Research articles for the 2020-10-09

A Consumption-Based Identification of Global Economic Uncertainty
Kim, Hwagyun,Lee, Eunhee,Park, Joon Y.
This paper identifies a global uncertainty factor by estimating an international asset pricing model featuring macroeconomic uncertainty with long-run risk factors. The global factor captures the time-varying fluctuations of common stochastic volatilities of consumption and dividend growths for countries, and reflects uncertainty in that it generates the highest volatility of volatility in transition period. The model quantitatively explains key asset pricing moments, and the estimated factor sharply increases during major international adverse events. Shocks to our global economic uncertainty factor significantly account for the likelihood of key economic and financial events, and outperforms existing measures of economic and financial uncertainties.

A Study of Applicability of Bankruptcy Prediction Models for Small Businesses
Kiseleva, Elena
The paper investigates predictive ability of existing bankruptcy prediction models suitable for small business by using dates of accounting report of Russian’s firms. Combination of financial ratios analysis with bankruptcy prediction models’ testing made it possible to identify the models showing high predictive ability. Study also provides applicable model for small business. The study is based on financial statements data about one hundred enterprises of small businesses, divided two types: failed and non-failed firms. The results of the study would be useful to many users such as financial analysts, board of small enterprises, lenders, auditors, tax inspectors.

Analysis of Real Property Insurance Market in Azerbaijan
Islamli, Nigar
This research paper indicates the latest situation in the insurance market about real property insurance after fires. It emphasizes the function of insurance in the economic development of the Azerbaijan economy. The primary aim of this research is to analyze the current state of the real property insurance in Azerbaijani and assess its potential. Recent fires in commercial shops have highlighted the importance of insurance. It uncovers the current circumstances that occurred among insureds and insurers. In addition, challenges faced by the insurance sector were investigated and certain policy recommendations were provided, in order to strengthen the position of the insurance sector in the country and future positive impacts on the development of the local economy. The indicated paper evaluates the newest progressions in the insurance climate in Azerbaijan including a target over fiscal, contractual, and commanding guide for the insurance sector in Azerbaijan. The effect of the administration guide of the insurance sector is analyzed and zones for additional activities are featured in the article. Within the framework of current research valuable recommendations and proposals have been provided.

Are CEOs’ Purchases More Profitable Than They Appear?
Armstrong, Chris,Blackburne, Terrence,Quinn, Phillip J.
Little is known about why CEOs voluntarily purchase shares of their firm other than because they expect to directly profit from doing so. However, since CEOs are risk-averse, highly un-diversified, and face litigation costs from trading on favorable private information, direct profits are unlikely to be the sole motive â€" especially considering that many of their purchases are ultimately unprofitable. We conjecture and find evidence that CEOs who have recently purchased shares are less likely to be terminated following poor performance and that this relation varies predictably depending on (i) the board’s access to alternative sources of information about the CEO, (ii) the CEOs’ expected cost of the purchase, and (iii) whether the CEO is already bonded via unrestricted shareholdings. Collectively, our results provide evidence that some CEOs voluntarily purchase shares despite the relatively high (opportunity) cost of foregone diversification â€" and, in some cases, outright un-profitability â€" of doing so to indirectly benefit by prolonging their tenure. Our estimates imply that the average direct (i.e., monetary) abnormal returns earned by CEOs’ purchases increase from 3% to 58% after accounting for the indirect benefit of prolonged tenure.

Asset-Rich and Cash-Poor: Which Older Adults Value Reverse Mortgages?
Fong, Joelle H.,Mitchell, Olivia S.,Koh, Benedict S.
Home equity represents a substantial share of retirement wealth for many older persons, particularly in Asia where national housing policies have encouraged homeownership. This paper explored the potential for reverse mortgages to help ‘asset-rich and cash-poor’ older Singaporeans unlock their home equity while ageing-in-place. The empirical analysis was based on a nationally representative survey of homeowners age 50+ in the 2018 Singapore Life Panel (N=6,258). Our analyses showed that the average older homeowner holds some 60% of total net wealth in housing equity, suggestive of high demand potential for reverse mortgage products. Nevertheless, actual interest in such products was much below potential demand. Only one in four older homeowners indicated interest in commercial reverse mortgages if these were to become available; a larger majority never heard of the financial product. Interest in reverse mortgages was positively associated with product awareness and self-rated product understanding. This implies that a critical step towards building consumer interest would be to enhance awareness of such products and simplify related contract terms. Having a mortgage, fewer children, financial literacy, and preparedness for retirement were also positively associated with interest level. These results have implications for targeted interventions to enhance consumer awareness and spur interest in reverse mortgages, especially in ageing societies where older people have built up substantial equity through the housing market over time.

Beta Estimation in the European Network Regulation Context: What Matters, What Doesn’t, What Is Indispensable
Bazhutov, Dmitry,Betzer, André,Stehle, Richard
Most studies on beta estimation look at the whole universe of stocks, we focus on a small subset. This concentration allows us to look at long beta time series of individual stocks and small peer groups in great detail. Our most important conclusions are: (1) Looking at the beta history is indispensable in the context of European network regulation, because sudden increases or decreases occur that only last for short time periods. By only looking at the beta on a specific date we may under- or overestimate the future beta significantly. A recent example stems from the coronavirus crisis. (2) One-year betas fluctuate strongly and in a random fashion around their long term mean and therefore are not useful in the regulatory context we look at. (3) The choice between a purely local, a European or a "World" beta may matter considerably, especially in certain time periods. (4) Weekly or daily betas seem to be better than monthly ones. (5) We recommend weekly betas and a five-year window. (6) Vasicek and Blume adjustments towards one lead to beta predictions that are too high.

Crash-sensitive Kelly Strategy built on a modified Kreuser-Sornette bubble model tested over three decades of twenty equity indices
Gerlach, J-C,Kreuser, Jerome L,Sornette, Didier
We present a modified version of the super-exponential rational expectations “Efficient Crashes” bubble model of (Kreuser and Sornette, 2019) with a different formulation of the expected return that makes clearer the additive nature of corrective jumps. We derive a Kelly trading strategy for the new model. We combine the strategy with a simplified estimation procedure for the model parameters from price time series. We optimize the control parameters of the trading strategy by maximizing the return-weighted accuracy of trades. This enables us to predict the out-of-sample optimal investment, purely based on in-sample calibration of the model on historical data. Our approach solves the difficult problem of selecting the portfolio rebalancing time, as we endogenize it as an optimization parameter. We develop an ex-ante backtest that allows us to test our strategy on twenty equity asset indices. We find that our trading strategy achieves positive trading performance for 95% of tested assets and outperforms the Buy-and-Hold-Strategy in terms of CAGR and Sharpe Ratio in 60% of cases. In our simulations, we do not allow for any short trading or leverage. Thus, we simply simulate allocation of 0-100% of one’s capital between a risk-free and the risky asset over time. The optimal rebalancing periods are mostly of duration around a month; thus, the model does not overtrade, ensuring reasonable trading costs. Furthermore, during crashes, the model reduces the invested amount of capital sufficiently soon to reduce impact of price drawdowns. In addition to the Dotcom bubble, the great financial crisis of 2008 and other historical crashes, our study also covers the most recent crash in March 2020 that happened globally as a consequence of the economic shutdowns that were imposed as a reaction to the spread of the Coronavirus across the world.

Did SFAS 166/167 Decrease the Information Asymmetry of Securitizing Banks?
Oz, Seda
Beginning in 2010, mandated Financial Accounting Standards No. 166 and 167 (SFAS 166/167) changed the consolidation rules of securitization entities and required more information about their securitization activities. I find that securitizing banks experienced a decrease in information asymmetry from the pre‐ to the post‐SFAS 166/167 periods, and that more visible securitizing banks are less sensitive to SFAS 166/167. These inferences are robust to a number of sensitivity analyses. This study is one of the first to provide evidence of the effects of SFAS 166/167 on the information asymmetry of securitizing banks.

Disagreement between Hedge Funds and Other Institutional Investors and the Cross-Section of Expected Stock Returns
Caglayan, Mustafa Onur,Celiker, Umut,Sonaer, Gokhan
We explore the prevalence and reasons for disagreements between hedge funds and other institutions in their trades of common stocks. We find that strong disagreements are twice as likely as agreements. Furthermore, stocks subject to strong disagreements (heavy buys from hedge funds and heavy sells by non-hedge funds) earn positive abnormal returns in the subsequent period. We show that in comparison to other institutions, hedge funds rely less on past returns and contemporaneous earnings news. We conclude that heterogeneity in the level of informativeness, return-chasing behavior, and trading in relation to earnings news are among the main reasons behind disagreements.

Factorisable Multitask Quantile Regression
Chao, Shih-Kang,Härdle, Wolfgang K.,Yuan, Ming
A multivariate quantile regression model with a factor structure is proposed to study data with many responses of interest. The factor structure is allowed to vary with the quantile levels, which makes our framework more flexible than the classical factor models. The model is estimated with the nuclear norm regularization in order to accommodate the high dimensionality of data, but the incurred optimization problem can only be efficiently solved in an approximate manner by off-the-shelf optimization methods. Such a scenario is often seen when the empirical risk is non-smooth or the numerical procedure involves expensive subroutines such as singular value decomposition. To ensure that the approximate estimator accurately estimates the model, non-asymptotic bounds on error of the the approximate estimator is established. For implementation, a numerical procedure that provably marginalizes the approximate error is proposed. The merits of our model and the proposed numerical procedures are demonstrated through Monte Carlo experiments and an application to finance involving a large pool of asset returns.

Job Security and CEO Compensation
Ang , James S.,Chen, Wei
We analyze a sample of 2,914 hiring contracts and show how job security plays a role in pay negotiation. We find a significant impact of job security on CEO pay using both firm and industry-level measures across US firms. In general, CEO candidates and the board members would trade pay for job security. We find this pay for job security also follows a hierarchy order; when a firm is unable to compensate job risk with a higher pay, the CEO will seek for alternative ways of compensation, including a severance agreement, a shorter grant vesting period, and an incentive plan metric that is easier to achieve. Moreover, job security has no value among risk-takers, and this value increases with CEO’s risk aversion. By examining the impact of job security under different market condition, we find that this pay concession disappears when the CEO labor market is more favorable to the CEOs.

Overnight Returns as a Market Timing Strategy
Kelly, Michael A.
Risk-adjusted overnight returns greatly exceed risk-adjusted daytime returns. Researchers use Jensen's alpha or the Fama-French three factor model for risk adjustment and use Fama-MacBeth regressions to test the estimated betas' predictivity. However, owning stocks only during the day or night is a market timing strategy. Using the non-linear factors proposed by Merton (1981) and Goetzmann et al. (2000), we show that the close-to-open strategy has negative market timing ability (measured by a non-linear regressor) with a positive selectivity alpha (measured by alpha), while the open-to-close strategy has the opposite. We also find that alpha is significant in down market periods.

Passive Investing: Luck or Patience?
Nixon, Terry
Passive investing over relatively long time-periods is a strategy followed by many individuals. In this paper, empirical evidence is presented beginning January 1950 that demonstrates that the success of this strategy is dependent not only on the length of the investment horizon, but also by the date of the initial investment. 10, 20, and 30-year periods are examined for both a lump sum initial investment and then for a monthly annuity investment. Longer horizons are shown to decrease the chance of an overall loss on a portfolio. However, different initial investment dates result in a wide range of ending portfolio values.

Predictive Analytics as an Instrument to Prevent Bankruptcy
Kiseleva, Elena,Efimov, Aleksei
As of today there are a lot of well-known bankruptcy prediction models. Scientists have been paying much attention to the development of bankruptcy prediction models since 1970. However, most of them are unable to predict bankruptcy, thereby making it impossible for firms to prevent it today. The paper researches predictive ability of existing bankruptcy prediction models suitable for small business. The primary goal of this paper is to examine methods of predictive analytics on empirical data and use obtained results to prevent bankruptcy of firms. Combination of predictive analytic methodology with bankruptcy prediction models’ testing made it possible to identify the models having high predictive ability. The study was carried out by using data bases of accounting reports of Russian’s firms. The study is based on the data from fifty small enterprises, divided into two types: failed and non-failed firms. Common-size and index analysis, financial ratios method and multidimensional statistical analysis were used to achieve the solution of the study.This paper makes these contributions: 1) summarizes methods of predictive analytics that indicate approaching bankruptcy; 2) evaluates the accuracy of bankruptcy prediction models one, two or three years before bankruptcy; 3) identifies models showing high predictive ability among small firms and provides a suitable model for small businesses. The results provided in the paper would be useful to many users such as scholars, financial analysts, board of small enterprises, lenders, auditors and tax inspectors.

Proposed Revisions to the DOL Shareholder Proposal
Feuer, Albert
On Sept. 4 the Department of Labor (DOL) issued proposed regulations governing ERISA plan fiduciary proxy votes. Public comments were due on or before October 5, 2020. This proposal would revoke and replace an existing regulation. An ERISA plan fiduciary would be generally required and permitted to vote in favor of a portfolio company resolution, including one pertaining to environmental, social and governance (ESG) issues, such as a say-on-pay resolution, only if the fiduciary finds the vote would increase the plan portfolio’s expected economic performance. The effect on the expected economic performance is determined without regard to the vote’s long-term effects on that portfolio, the fiduciary policies with respect to similar resolutions of other portfolio companies, or the actions of other shareholders of the company. The proposal, also, allows ERISA plan fiduciaries to not vote for any resolutions of companies that constitute such a small part of the plan’s investment portfolio that they would not have a material impact on the portfolio’s expected economic performance. This may include resolutions for portfolio companies, such as a portfolio company in an S&P 500® Index portfolio constructed by the plan.The proposal would discourage ERISA fiduciaries and non-ERISA plan fiduciaries from being ESG investor activists. Investor activists engage the management of a portfolio company both individually and in concert with other investors. Such activism includes direct interactions with a company’s managers and directors, as well as casting proxy votes.The article argues that it is advisable for the DOL to revise the proposal to be consistent with ERISA, and the DOL historical and current policy of permitting ERISA fiduciaries to engage in investor activism, if such activism does not reduce the plan’s expected economic performance. The effect on the expected economic performance is determined for the appropriate investment horizon. The effect takes into account the actions of the fiduciary with respect to other portfolio companies of the plan, and the actions of other shareholders in the portfolio company.

Real Effects of Foreign Exchange Risk Migration: Evidence from Matched Firm-Bank Microdata
Abbassi, Puriya,Bräuning, Falk
When firms trade forward contracts with banks to protect foreign currency cash flows against exchange rate movements, foreign exchange risk migrates to the banking sector. We show how this migrated risk may induce systemic repercussions with severe implications for the real economy. For identification, we exploit the Brexit referendum in June 2016 as a quasi-natural experiment in combination with detailed microdata on forward contracts and the credit register in Germany. Before the referendum, firms substantially increased their use of derivatives in response to the heightened uncertainty; banks, in providing these contracts, did not fully intermediate the risk and retained a large share of it on their own books. The depreciation of the British pound in response to the referendum's outcome posed a shock to the capital of ex-ante exposed banks. Banks, especially weakly capitalized ones, absorbed these losses by cutting back credit to all firms, including those unlikely to have had any exchange rate exposure to begin with. Firms that had ex-ante borrowing relationships with banks facing losses experienced a larger reduction in credit and a greater decline in investment compared with their industry peers, thereby contributing to the aggregate investment contraction. We also find these effects to be more pronounced for small firms, which is consistent with credit market frictions being rooted in asymmetric information problems.

Replicas: Have Hedge Funds Re-Resurrected as Traditional Beta?
Cherian, Joseph,Kon, Christine,Li, Ziyun
We find market risk factors explain up to 81% of North American and Asian hedge fund portfolios’ variance, while out-of-sample clones have up to 98% correlation with realized returns. So-called “market neutral” funds take on significant short-term market bets, where rolling beta clones display up to 74% correlation with realized returns. Overall, returns attributable to skill declined systematically, with clones outperforming hedge fund indices. In our novel event study, we demonstrate clones are resilient to drawdowns, outperforming the market during China's COVID-19 lockdown and the WHO's pandemic announcement; 10-day market-adjusted CARs ranged from 2.46% â€" 9.71% for these dates.

The Australian SGL System: A Community Balance Sheet Analysis
Evans, John R.,Razeed, Abdul
The Australian SGL system impacts many aspects of Australians’ well-being through reduced wages to fund the SGL contributions, an enhanced retirement standard of living, government costs of the Age Pension system, employment in the financial services industry and providing a pool of capital for the Australian economy. The paper argues that in balance, taking into account both qualitative and quantitative analysis, the SGL system has a negative impact on Australians’ well-being, and suggests alternative structures that would at least neutralize the current negative impact and possibly enhance it.

The Relevance of Relationship Lending in Times of Crisis
Amiram, Dan,Rabetti, Daniel
While relationship lending is usually associated with long-term gains between parties, under traditional corporate financing, little is known about its relevance during times of crisis - where size and velocity in which emergency funds are provided may define a borrower's ability to prevent an extremely negative event. This paper attempts to address it by exploring the effects of relationship lending in the Paycheck Protection Program (PPP) loans. We find that relationship borrowers, those with PPP lender's past banking relationships, receive larger loans and faster approvals than transaction borrowers, those without past banking relationships. The results are statistically and economically significant across several specifications. Interestingly, firms are more likely to be in violation of PPP rules when a relationship exists, revealing adverse costs of relationship lending. However, relationship firms are twice as likely to return PPP funds earlier, consistent with lenders' bargaining power. Overall, our findings suggest that relationship lending effects are persistent outside traditional corporate financing and relevant component of firms' survival in times of crisis.

The Role of Government and Private Institutions in Credit Cycles in the U.S. Mortgage Market
Adelino, Manuel,McCartney, W. Ben,Schoar, Antoinette
The distribution of combined loan-to-value ratios (CLTVs) for purchase mortgages has been remarkably stable in the U.S. over the last 25 years. But the source of high-CLTV loans changed during the housing boom of the 2000s, with private securitization replacing FHA and VA loans directly guaranteed by the government. This substitution holds within ZIP codes, properties, and borrower types. Furthermore, the two groups exhibit similar delinquency rates. These findings suggest credit expanded predominantly through the increase in asset values rather than a relaxation of CLTV constraints, which supports models of the collateral channel or broad changes in house price expectations.

Uncertain Times and Early Predictions of Bank Failure
Goenner, Cullen F.
The Great Financial Crisis shows that bank failure in the United States, while rare, is a concern during uncertain times. Interest here is in the ability to predict future failures at the start of a crisis, when the recent past has few events on which to base inferences. I show that policy makers using estimates based on the Savings and Loans crisis would identify in early 2009 that 2.0% of banks were in critical condition and 7.0% were unhealthy. This is comparable to the 1.7% of banks that failed within a year and the 3.9% of banks that would fail during the crisis.