Research articles for the 2020-09-24

A New Wolf in Town? Pump-and-Dump Manipulation in Cryptocurrency Markets
Dhawan, Anirudh,Putniņš, Tālis J.
We show that cryptocurrency markets are plagued by pump-and-dump manipulation, with at least 355 cases in seven months. Unlike stock market manipulators, cryptocurrency manipulators openly declare their intentions to pump specific coins, rather than trying to deceive investors. Puzzlingly, people join in despite negative expected returns. In a simple framework, we demonstrate how overconfidence and gambling preferences can explain participation in these schemes, and find strong empirical support for both mechanisms. Pumps generate extreme price distortions of 65% on average, abnormal trading volumes in the millions of dollars, and large wealth transfers between participants. These manipulation schemes are likely to persist as long as regulators and exchanges turn a blind eye.

A Note on Size-Based Capital Asset Pricing Model
Kwame Boamah-Addo,Brandon Flores,Jakob Lovato,Andrey Sarantsev

The purpose of this short note is to state the Capital Asset Pricing Model for size deciles from Center for Research in Securities Prices database, and construct a related continuous-time model for Stochastic Portfolio Theory with rank-based Levy particles. We regress equity premia for size deciles over the equity premium for the top decile, and modify the model for continuous time. We simulate the resulting capital distribution curve.

A note on the impact of news on US household inflation expectations
Ben Zhe Wang,Jeffrey Sheen,Stefan Trück,Shih-Kang Chao,Wolfgang Karl Härdle

Monthly disaggregated US data from 1978 to 2016 reveals that exposure to news on inflation and monetary policy helps to explain inflation expectations. This remains true when controlling for household personal characteristics, perceptions of government policy effectiveness, future interest rates and unemployment expectations, and sentiment. We find an asymmetric impact of news on inflation and monetary policy after 1983, with news on rising inflation and easier monetary policy having a stronger effect in comparison to news on lowering inflation and tightening monetary policy. Our results indicate the impact on inflation expectations of monetary policy news manifested through consumer sentiment during the lower bound period.

A test for Heckscher-Ohlin using value-added exports
Philipp Koch,Clemens Fessler

Empirical evidence for the Heckscher-Ohlin model has been inconclusive. We test whether the predictions of the Heckscher-Ohlin Theorem with respect to labor and capital find support in value-added trade. Defining labor-capital intensities and endowments as the ratio of hours worked to the nominal capital stock, we find evidence against Heckscher-Ohlin. However, taking the ratio of total factor compensations, and thus accounting for differences in technologies, we find strong support for it. That is, labor-abundant countries tend to export value-added in goods of labor-intensive industries. Moreover, differentiating between broad industries, we find support for nine out of twelve industries.

Adapting to Radical Change: The Benefits of Short-Horizon Investors
Giannetti, Mariassunta,Yu, Xiaoyun
We show that following shocks that change an industry’s competitive environment, firms with more short-term institutional investors experience smaller drops in sales and investment and have better long-term performance than similar firms affected by the shocks. To do so, these firms introduce new products, file more trademarks, intensify their innovation efforts, conduct more diversifying acquisitions, and have higher executive turnover in the aftermath of the shocks. Our findings suggest that firms with more short-term investors adapt better to the new competitive environment. Endogeneity of institutional ownership and other selection problems do not appear to drive our findings.

Advanced Mathematical Business Strategy Formulation Design
Song-Kyoo Kim

This paper deals with the explicit design of strategy formulations to make the best strategic choices from a conventional matrix form of representing strategic choices. The explicit strategy formulation is an analytical model which is targeted to provide a mathematical strategy framework to find the best moment for strategy shifting to prepare rapid market changes. This theoretical model could be adapted into practically any strategic decision making situation when a strategic formulation is described as a matrix form with quantitative measured decision parameters. Analytically tractable results are obtained by using the fluctuation theory and these results are capable to predict the best moments of changing strategies in a matrix form. This research helps strategy decision makers who want to find the optimal moments of shifting present strategies.

Algorithmic Trading and Market Quality
Broussard, John Paul,Nikiforov, Andrei L.,Osmekhin, Sergey
A unique data set from NASDAQ OMX Nordic allows a deep analysis of trader types’ activity and provides evidence on the roles played in the trading ecosystem. We specifically investigate the impact of algorithmic traders on market quality relative to the activities of other market participants under various conditions. We find that relative to other traders, algorithmic traders contribute to lower spreads, especially during highly volatile markets, and provide more shares traded at the NBBO. We also identify the main determinants of algorithmic traders’ liquidity provisions and order cancellation patterns.

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

Global historical series spanning the last two centuries recently became available for primary energy consumption (PEC) and Gross Domestic Product (GDP). Based on a thorough analysis of the data, we propose a new, simple macroeconomic model whereby physical power is fueling 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 energy from food. In a consistent model, both physical capital and human capital are fed by PEC and represent a form of stored energy. In the following century, from 1920 to 2016, GDP grows quicker than PEC. Periods of quasi-linearity of the two variables are separated by distinct jumps, which can be 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 modeling and for political management of the climate crisis and the energy transition.

Bank Heterogeneity and Financial Stability
Goldstein, Itay,Kopytov, Alexandr,Shen, Lin,Xiang, Haotian
We study how heterogeneity in banks' asset holdings affects fragility. In the model, banks face a risk of bank runs and have to liquidate long-term assets in a common market to repay runners. Liquidation prices are depressed when many banks sell their assets at the same time. When banks are homogeneous, their selling behaviors are synchronized, and bank runs are exacerbated. We show that differentiating banks to some extent enhances the stability of all banks, even those whose asset performance ends up being weaker. Our analyses provide new insights about the regulation of banking sector's architecture and the design of government support during crises.

Beyond Basis Basics: Liquidity Demand and Deviations from the Law of One Price
Hazelkorn, Todd M.,Moskowitz, Tobias J.,Vasudevan, Kaushik
We argue that deviations from the law of one price between futures and spot prices, known as bases, capture important information about liquidity demand for equity market exposure in global equity index futures markets. We show that bases (1) co-move with dealer and investor futures positions, (2) are contemporaneously positively correlated with spot and futures markets with the same sign, and (3) negatively predict futures and spot market returns with the same sign. These findings are uniquely consistent with our liquidity demand model and distinct from other explanations for bases, such as arbitrage opportunities or intermediary balance sheet costs. We show persistent supply-demand imbalances for equity index exposure reflected in bases, where compensation for meeting liquidity demand for that exposure is large (5-6% annual premium).

Corporate Social Responsibility and Sustainable Finance: A Review of the Literature
Liang, Hao,Renneboog, Luc
This paper reviews the state of research in the emerging literature of corporate social responsibility (CSR) and sustainable finance. We draw from research in finance, economics, accounting, and management and try to provide a comprehensive overview of the key topics in this field.Section 1 reviews the literature on corporate social responsibility. We begin by comparing various definitions on CSR, and defining the scope of incorporating Environmental, Social, and Governance (ESG) considerations into corporate management and investor’s portfolio decisions. We then review the economic and management theories on the objective functions of the firm, with a focus on whether corporations should internalize the externalities they create, and whether they should be accountable to shareholders or to the broader group of stakeholders. We next review the three major views on CSR in the economics and finance literature, supported by the empirical evidences on how CSR can affects financial performance, firm value, and various stakeholders’ welfare.Section 2 reviews the measurement of ESG and corporate ESG disclosures. For ESG measurement, we introduce various firm-level ratings by ESG data providers on public corporations that are widely used in the literature. We also highlight the potential challenges with these ratings, including their inconsistencies, industry- and country-adjustment, and the validity of the rating methodology. We next provide an overview on ESG disclosureâ€"a major source of data that are used to construct the ratingsâ€"by drawing from the accounting literature and focus on sustainability and integrated reporting practice.Section 3 takes an investor’s perspective and reviews the literature of sustainable, responsible, and impact investing (SRI). We focus on the return implication of investing in the stocks of socially responsible firms, as well as the performance of SRI funds. We also discuss the role of institutional investors in driving portfolio companies’ ESG performance, as well as their investment strategies, including negative screening, positive screening, as well as activism through engagement and proxy voting. We also review recent studies that develop the ESG-efficient frontier and discuss ESG factor investing (considering sustainability as a risk factor). Finally, we introduce the emerging literature of impact investing by private equity.Section 4 reviews the literature on green financing and economic decarbonization. We focus on the rapidly growing market of green bond and its risk-return profile. We also review some recent papers that investigate how climate change may affect financial markets and investor behavior. Section 5 concludes.

Costly Arbitrage and Skewness Pricing: Evidence from a First-day Price Limit Reform in China
Yao, Jing,Zheng, Zexin
We examine the effect of limits to arbitrage on skewness pricing using a reform of China’s stock market that limits first-day price movements. We document that the reform causes a significant increase in the impact of IPOs’ expected skewness on both their initial returns and trading interference effect, especially for IPO firms that are sensitive to the limitations imposed by price limits. We also find that the skewness pricing effect triggered by the reform persists along the idiosyncratic (not systematic) dimension. The results are consistent with the notion that price movement constraints contribute to limits to arbitrage and hence have a positive effect on skewness pricing.

Deep Calibration of Financial Models: Turning Theory Into Practice
Büchel, Patrick,Kratochwil, Michael,Nagl, Maximilian,Roesch, Daniel
The calibration of financial models is a laborious, time-consuming and expensive task, which needs to be performed frequently by financial institutions. Recently, the application of artificial neural networks (ANNs) for calibration has gained interest. This paper provides the first comprehensive empirical study on the application of ANNs for calibration based on observed market data. We benchmark the performance against a real-life calibration framework. We show that the results of an ANN based calibration framework are very competitive and derive guidelines for its practical implementation to enhance and accelerate managerial decisions. Furthermore, we show that our calibrated parameters are more stable over time, enabling more reliable risk reports and business decisions.

Discriminatory Versus Uniform Auction: Evidence From JGB Market
Hattori, Takahiro,Takahashi, Shogo
The Japanese government switched the auction format from uniform to discriminatory for its 30-year Japanese government bond (JGB) in 2007. Taking advantage of this policy change, we examine data before and after this period to assess whether the switch has lowered the borrowing costs of the Japanese government. Although Japan generally uses discriminatory auctions, relatively illiquid and newer bonds tend to be issued through the uniform auction format. Once the Japanese government perceived a sufficient number of investors with similar valuations of the 30-year JGBs, it switched the auction mechanism from uniform to discriminatory. Our empirical results show that this policy change lowered its borrowing cost, consistent with the theoretical prediction.

Dividend Suspensions and Cash Flow Risk during the COVID-19 Pandemic
Pettenuzzo, Davide,Sabbatucci, Riccardo,Timmermann, Allan
We examine the effect of the COVID-19 pandemic on firms’ decisions to suspend dividends and estimate a model that quantifies the effect of suspensions on growth in aggregate dividends. Our estimates show that dividend suspensions had a large impact on expected future dividend growth and also helped predict the sharp declines observed in broader measures of economic activity. Firms with high leverage and low profitability were more likely to have suspended their dividends during the pandemic as were firms with the largest negative stock returns prior to the dividend announcement date. While firms that suspended their dividends experienced large negative abnormal returns, firms that substantially reduced but did not entirely eliminate dividends saw large positive abnormal returns around the announcement date.

Fencing Off Silicon Valley: Cross-Border Venture Capital and Technology Spillovers
Akcigit, Ufuk,Ates, Sina,Lerner, Josh,Townsend, Richard,Zhestkova, Yulia
The treatment of foreign investors has been a contentious topic in U.S. entrepreneurship policy in recent years. This paper examines foreign corporate investments in Silicon Valley from a theoretical and empirical perspective. We model a setting where such funding may allow U.S. entrepreneurs to pursue technologies that they could not otherwise, but may also lead to spillovers to the overseas firm providing the financing and the nation where it is based. We show that despite the benefits from such inbound investments for U.S. firms, it may be optimal for the U.S. government to raise their costs to deter investments. Using as comprehensive as possible a sample of investments by non-U.S. corporate investors in U.S. start-ups between 1976 and 2015, we find evidence consistent with the presence of knowledge spill-overs to foreign investors.

Financial Constraints and Product Market Decisions: The Role of Production Cycles
Mendes, Diogo
This paper studies how financial frictions affect product market decisions. As different products have different production cycles and generate cash-flow at different maturities, companies may adjust product mix in order to alleviate financial constraints. I use the wine sector in Portugal as a laboratory because product mix decisions can be identified and linked to cash-flow maturity. I exploit a banking regulatory shock which impacted negatively on credit availability, and I find that credit constrained firms change their product mix in response to the shock. Firms shift from long cash-flow maturity products to shorter ones. My results suggest that the adverse impact of financial constraints on product markets may be exacerbated with longer, less-flexible, production cycles.

Fondo De Pensiones: Modelo Español Y Noruego (Pension Funds: Spanish and Norwegian Model)
Gómez Marroquín, Asier
Spanish abstract: El objetivo del presente trabajo es analizar los principales problemas que presenta el sistema de pensiones vigente en el Estado español para consecutivamente analizar y poner las guías para la implementación de nuevos modelos como es el del fondo soberano noruego. En primer lugar, se realizará un análisis del actual sistema público de pensiones español al mismo tiempo que se irán pormenorizando sus dos principales problemas y cuestionando su viabilidad a corto y largo plazo. Esta primera parte del trabajo concluirá con un examen de otros métodos de ahorro privado complementarios como son los planes de pensiones. Posteriormente y en una segunda parte, se presentará un exhaustivo estudio del “modelo noruego” del que se detallarán rentabilidad, diversificación de riesgo, transparencia y otros factores determinantes. Este apartado concluirá con una valoración de las posibilidades reales de implantar el sistema de pensiones noruego en nuestro país.English abstract: The objective of this paper is to highlight the main problems of the current pension system in Spain to later analyse and put the guidelines for the implementation of new models, such as the Norwegian sovereign fund. In the first place, an analysis of the current Spanish public pension system will be carried out, being its two main problems detailed. At the same time, its viability will be questioned in the short and long term. This first part of the work will conclude with an examination of other complementary private savings methods, such as pension plans. Afterwards, an exhaustive study of the "Norwegian model" will be presented, in which yield, risk diversification, transparency and other determining factors will be specified. This section will eventually assess the real possibilities of implementing the Norwegian pension system in our country.

Human and financial cost of COVID-19
Nick James,Max Menzies

This paper analyzes the human and financial costs of the COVID-19 pandemic on 92 countries. We compare country-by-country equity market dynamics to cumulative COVID-19 case and death counts and new case trajectories. First, we examine the multivariate time series of cumulative cases and deaths, particularly regarding their changing structure over time. We reveal similarities between the case and death time series, and key dates that the structure of the time series changed. Next, we classify new case time series, demonstrate five characteristic classes of trajectories, and quantify discrepancy between them with respect to the behavior of waves of the disease. Finally, we show there is no relationship between countries' equity market performance and their success in managing COVID-19. Each country's equity index has been unresponsive to the domestic or global state of the pandemic. Instead, these indices have been highly uniform, with most movement in March.

Machine Learning Panel Data Regressions with an Application to Nowcasting Price Earnings Ratios
Babii, Andrii,Ball, Ryan T.,Ghysels, Eric,Striaukas, Jonas
This paper introduces structured machine learning regressions for prediction and nowcasting with panel data consisting of series sampled at different frequencies. Motivated by the empirical problem of predicting corporate earnings for a large cross-section of firms with macroeconomic, financial, and news time series sampled at different frequencies, we focus on the sparse-group LASSO regularization. This type of regularization can take advantage of the mixed frequency time series panel data structures and we find that it empirically outperforms the unstructured machine learning methods. We obtain oracle inequalities for the pooled and fixed effects sparse-group LASSO panel data estimators recognizing that financial and economic data exhibit heavier than Gaussian tails. To that end, we leverage on a novel Fuk-Nagaev concentration inequality for panel data consisting of heavy-tailed $\tau$-mixing processes which may be of independent interest in other high-dimensional panel data settings.

Microfinance Can Raise Incomes: Evidence from a Randomized Control Trial in China
Cai, Shu,Park, Albert,Wang, Sangui
This study evaluates the impact of a randomized control trial (RCT) in China that introduced externally funded village credit funds in poor, rural villages. In contrast to recent RCT-based studies that have failed to find evidence of significant increases in income from microfinance interventions, we find that the Chinese program significantly raises household income and reduces poverty. We explore possible explanations as to why the estimated impacts may be greater in China: lump-sum repayments, lower interest rates, less access to formal credit before the program, and greater potential returns from off-farm employment opportunities that are credit-constrained.

Performance Evaluation of Mudra Bank (With Special Reference to State of Madhya Pradesh)
Verma, Toran Lal
he theme of ‘United Nations International MSME day’ reads “Small Businesses, Big Impact.” All over the world, MSMEs have been recognized as growth engines of economic development. In India too, MSMEs have been instrumental in shaping the growth trajectory of the economy. But these small businesses face many problems since their inception to their day to day operations. Major problem of small business in India is lack of finance. Given this fact, there was an urgent need of an institution which would provide affordable loans to micro and small businesses engaged in manufacturing, trading, and service activities. Micro unit’s development and refinance agency (MUDRA) Bank is established with an aim to provide affordable loans and nurture the entrepreneurial talents in the micro and small business sector. The bank with various ambitious objectives is a fully owned subsidiary of SIDBI which is a principal financial institution for promotion and growth of Micro, Small and Medium Enterprises (MSMEs) in the country. The bank aims to provide financial support to entrepreneurs in three categories namely Shishu, Kishor and Tarun. This paper attempts to study the inception of MUDRA Bank and evaluate its performance in India and the state of Madhya Pradesh.

Portfolio Optimization on Multivariate Regime Switching GARCH Model with Normal Tempered Stable Innovation
Cheng Peng,Young Shin Kim

We propose a Markov regime switching GARCH model with multivariate normal tempered stable innovation to accommodate fat tails and other stylized facts in returns of financial assets. The model is used to simulate sample paths as input for portfolio optimization with risk measures, namely, conditional value at risk and conditional drawdown. The motivation is to have a portfolio that avoids left tail events by combining models that incorporates fat tail with optimization that focuses on tail risk. In-sample test is conducted to demonstrate goodness of fit. Out-of-sample test shows that our approach yields higher performance measured by Sharpe-like ratios than the market and equally weighted portfolio in recent years which includes some of the most volatile periods in history. We also find that suboptimal portfolios with higher return constraints tend to outperform optimal portfolios.

Revenue allocation in Formula One: a pairwise comparison approach
Dóra Gréta Petróczy,László Csató

A model is proposed to allocate Formula One World Championship prize money among the constructors. The methodology is based on pairwise comparison matrices, allows for the use of any weighting method, and makes possible to tune the level of inequality. We introduce an axiom called scale invariance, which requires the ranking of the teams to be independent of the parameter controlling inequality. The eigenvector method is revealed to violate this condition in our dataset, while the row geometric mean method always satisfies it. The revenue allocation is not influenced by the arbitrary valuation given to the race prizes in the official points scoring system of Formula One and takes the intensity of pairwise preferences into account, contrary to the standard Condorcet method. Our suggestion can be used to share revenues among groups when group members are ranked several times.

Smart Beta Made Smart
Johansson, Andreas,Sabbatucci, Riccardo,Tamoni, Andrea
We construct synthetic, tradable risk factors (e.g., tradable HML and MOM) and individual factor legs (e.g., growth and value) using optimal combinations of large and liquid mutual funds and ETFs based on their holdings. We show that a large fraction of existing smart beta funds are simply market funds, and that both retail and institutional investors are not able to harvest the unconditional factor risk premia, with the exception of the value premium. We conclude that the investable set of strategies available to investors may be smaller than previously thought. We also show that smart beta funds' names might not be indicative of the actual fund strategy, although daily flows to smart beta strategies suggest that naive investors tend to get exposure to smart beta strategies based on funds' names. Our analysis has several important implications, including how we evaluate portfolio managers and cross-sectional returns' anomalies.

Statistical Analysis of the Relation Between the Developmental Status of Nations and Their Banks’ Npa Using Hypothesis Testing
Chawla, Gangesh ,Gupta, Mridul,Sharma, Nimish ,Aggarwal, Keshav ,M. Singari, Ranganath ,Kumar, Nand
HDI is the most common index which is used in measuring the development of a nation. Life expectancy, literacy rate and per capita income are the main components of Human Development Index (HDI). Health, standard of living and education are the main aspects it covers. The subsequent topic this paper covers is Non-performing Assets (NPA) or Bad Loans. These NPAs are caused due to an improper structure of lending and a lack of application of suitable technology in the process. The loan taking capability of the masses is influenced by another factor called Economic Inequality, which is the difference between individuals or populations in terms of income, wealth and assets. We will observe the effect of health, education and standard of living of a country on NPAs of Banks of that country which in turn affects the interest rates levied on loans, thereby swaying the loan taking capacity of the people. In our research we analyse the NPAs of top 2 banks of 15 developing nations and 14 developed nations and formulate a Statistical Model to determine its relation with their respective HDI. We make use of T-Test and a statistical approach to develop the model and come up with a suitable conclusion.

Trade Credit and the Transmission of Unconventional Monetary Policy
Adelino, Manuel,Ferreira, Miguel A.,Giannetti, Mariassunta,Pires, Pedro
We show that trade credit in production networks is important for the transmission of unconventional monetary policy. We find that firms with bonds eligible for purchase under the European Central Bank’s Corporate Sector Purchase Program act as financial intermediaries and extend more trade credit to their customers. The increase in the provision of trade credit flows is more pronounced from core countries to periphery countries and for financially constrained customers. Customers increase investment and employment in response to the increase in trade financing, while suppliers expand their customer base, potentially contributing to upstream industry concentration. Our findings suggest that the trade credit channel of monetary policy produces heterogeneous effects across regions, industries, and firms.

Trade Imbalance Network and Currency Risk Premia
Hou, Ai Jun
This paper proposes a new risk factor based on a multi-country’s trading imbalance network to explain foreign exchange rate fluctuations and currency risk premia associated with a currency carry trade strategy. We build a directed in-degree trading network of global countries linked by their pair wise trading deficit using import and export trading data collected from UN comtrade. After sorting currencies portfolios based on the centrality scores, the new risk factor, i.e., CMP, Central Minus Peripheral is created by buying central countries currency and shorting peripheral countries currency. We then use this factor to explain the risk premium of the foreign currency and currency excess returns cross sectional variations. Our results confirm the explanatory power of the new risk factor. We show that the new measure has signifcant explanatory power to currency risk premium and corsssectional foreign currency excess returns after controlling the existing risk factors of e.g., Lustig and Verdelhan (2011), Corte et al. (2016), and Richmond (2019).

Value Creation in Private Equity
Biesinger, Markus,Bircan, Cagatay,Ljungqvist, Alexander
We open up the black box of value creation in private equity with the help of confidential information on value creation plans and their execution. Plans are tailored to each portfolio company’s needs and circumstances, have become more hands-on, and vary with deal type, ownership, growth strategy, and geographic focus. Successful execution is subject to resource constraints, economies of specialization, and diminishing returns, and varies systematically across funds. Successful execution is a key driver of investor returns, especially in growth, buyout, and secondary deals. Company operations and profitability improve in ways consistent with successful execution, even beyond PE funds’ exit.

When Does Board Diversity Benefit Shareholders? Strategic Deadlock as a Commitment to Monitor
Ljungqvist, Alexander,Raff, Konrad
We ask when and how a diverse board can benefit shareholders. Board diversity may be value-increasing even if some directors have agendas that are not perfectly aligned with shareholders' interests. Diversity commits the board to a high information standard because directors with opposing agendas are deadlocked unless they have persuasive information in support of the optimal course of action. Since deadlock is costly, diversity strengthens directors' incentives to gather information ex ante, which raises expected firm value. Diversity is more likely desirable if the firm's information environment is poor and if directors' opposing agendas are accompanied by sufficiently strong incentives for value maximization. However, if directors cannot credibly communicate their information, a homogeneous board dominates a diverse board.