Research articles for the 2020-10-25

A Machine Learning Based Regulatory Risk Index for Cryptocurrencies
Xinwen Ni,Wolfgang Karl Härdle,Taojun Xie

Cryptocurrencies' values often respond aggressively to major policy changes, but none of the existing indices informs on the market risks associated with regulatory changes. In this paper, we quantify the risks originating from new regulations on FinTech and cryptocurrencies (CCs), and analyse their impact on market dynamics. Specifically, a Cryptocurrency Regulatory Risk IndeX (CRRIX) is constructed based on policy-related news coverage frequency. The unlabeled news data are collected from the top online CC news platforms and further classified using a Latent Dirichlet Allocation model and Hellinger distance. Our results show that the machine-learning-based CRRIX successfully captures major policy-changing moments. The movements for both the VCRIX, a market volatility index, and the CRRIX are synchronous, meaning that the CRRIX could be helpful for all participants in the cryptocurrency market. The algorithms and Python code are available for research purposes on

Bitcoin Trading is Irrational! An Analysis of the Disposition Effect in Bitcoin
Jürgen E. Schatzmann,Bernhard Haslhofer

Investors tend to sell their winning investments and hold onto their losers. This phenomenon, known as the \emph{disposition effect} in the field of behavioural finance, is well-known and its prevalence has been shown in a number of existing markets. But what about new atypical markets like cryptocurrencies? Do investors act as irrationally as in traditional markets? One might suspect this and hypothesise that cryptocurrency sells occur more frequently in positive market conditions and less frequently in negative market conditions. However, there is still no empirical evidence to support this. In this paper, we expand on existing research and empirically investigate the prevalence of the disposition effect in Bitcoin by testing this hypothesis. Our results show that investors are indeed subject to the disposition effect, tending to sell their winning positions too soon and holding on to their losing position for too long. This effect is very prominently evident from the boom and bust year 2017 onwards, confirmed via most of the applied technical indicators. In this study, we show that Bitcoin traders act just as irrationally as traders in other, more established markets.

COVID-19 Impacts on Bank Stability in a Liquidity-Backed Environment
Ozsoy, S. Mehmet,Rasteh, Mehdi,Yönder, Erkan,Yucel, Meric
The Great Recession has been more of a bank governance issue. In the COVID-19 crisis, the liquidity needs of firms have been the immediate problem due to lockdowns and banks have responded to these with the support of government and central bank programs. Our paper is the first evaluating the impact of the geographic exposure to COVID-19 on bank stability and performance in such a liquidity-backed environment. We find that bank stability and performance worsen by COVID-19 exposure. The liquidity injections seem to be only helpful for banks with higher equity capital capacity that were able to increase loan supply. We also find that banks operating in locations with high-density black populations suffer from COVID-19 exposure while their peers do not, potentially hinting at differences in accessibility to credit expansion.

Determinants of Financial Performance of Microfinance Banks in Kenya
King'ori S. Ngumo,Kioko W. Collins,Shikumo H. David

Microfinance provides strength to boost the economic activities of low-income earners and thus contributes to eradication of poverty. However, microfinance institutions face stringent competition from commercial banks; the growth of microloan activities of commercial banks may confront microfinance institutions with increased competition for borrowers. In Kenya, the micro finance sector has extremely high competition indicated by the shifting market share and profitability. This study sought to examine the determinants of financial performance of Microfinance banks in Kenya. The study adopted a descriptive research design and used secondary data from 7 Microfinance banks for a period of 5 years from 2011 to 2015. The data collected was analyzed using correlation and regression analysis. The study found a positive and statistically significant relationship between operational efficiency, capital adequacy, firm size and financial performance of microfinance banks in Kenya. However, the study found an insignificant negative relationship between liquidity risk, credit risk and financial performance of microfinance banks in Kenya. The study concluded that there is direct relationship between operational efficiency, capital adequacy, firm size and financial performance of microfinance banks in Kenya.

Determinants of Lending to Small and Medium Enterprises by Commercial Banks in Kenya
David Haritone Shikumo,Mwangi Mirie

Small and Medium Enterprises (SMEs) access to external finance is an issue of significant research interest to academicians. Commercial banks consider many SMEs not to be credit worthy because of their inability to meet some banking requirements. Hence, the objective of this study was to investigate what determines lending to SMEs by commercial banks in Kenya. To achieve the study objectives, a descriptive research design was employed. The study undertook a census of the 43 commercial banks in Kenya, with full data being obtained for 36 institutions. The study used secondary data from the annual published reports of commercial banks in Kenya for a period of 5 years from 2010-2014. The data collected was analyzed through the multiple linear regression using the Statistical Package for Social Studies version 20.The study established that bank size and liquidity significantly influences (positively and negatively, respectively) lending to SMEs by commercial banks in Kenya while credit risk and interest rates have no significant influence on lending to SMEs by commercial banks in Kenya. The study recommends that lending to SMEs by commercial banks in Kenya be enhanced by adopting policies that grow the commercial banks.

Harnessing Ambient Sensing & Naturalistic Driving Systems to Understand Links Between Driving Volatility and Crash Propensity in School Zones: A generalized hierarchical mixed logit framework
Behram Wali,Asad Khattak

With the advent of seemingly unstructured big data, and through seamless integration of computation and physical components, cyber-physical systems (CPS) provide an innovative way to enhance safety and resiliency of transport infrastructure. This study focuses on real world microscopic driving behavior and its relevance to school zone safety expanding the capability, usability, and safety of dynamic physical systems through data analytics. Driving behavior and school zone safety is a public health concern. The sequence of instantaneous driving decisions and its variations prior to involvement in safety critical events, defined as driving volatility, can be a leading indicator of safety. By harnessing unique naturalistic data on more than 41,000 normal, crash, and near-crash events featuring over 9.4 million temporal samples of real-world driving, a characterization of volatility in microscopic driving decisions is sought at school and non-school zone locations. A big data analytic methodology is proposed for quantifying driving volatility in microscopic real-world driving decisions. Eight different volatility measures are then linked with detailed event specific characteristics, health history, driving history, experience, and other factors to examine crash propensity at school zones. A comprehensive yet fully flexible state-of-the-art generalized mixed logit framework is employed to fully account for distinct yet related methodological issues of scale and random heterogeneity, containing multinomial logit, random parameter logit, scaled logit, hierarchical scaled logit, and hierarchical generalized mixed logit as special cases. The results reveal that both for school and non-school locations, drivers exhibited greater intentional volatility prior to safety-critical events... ...

Impact of Early COVID-19 Pandemic on the US and European Stock Markets and Volatility Forecasting
Rahman, Mohammad Mazibar,Gupta, Anupam Das,Uddin, Mohammed Mohi,Hossain, Mahmud,Abedin, Mohammad Zoynul
This study examines the impact of COVID-19 on US and European stock indexes, implied volatility (IV) indices, and proposes forecasting accuracy of IV indices form daily data of March 2005 to May 2020, having an out-of-sample assessment of COVID-19. The empirical findings of Canonical Correlation Analysis (CCA) contribute significant insight into COVID-19 over the US and European stock indexes. This result shows that the death and recovery cases of COVID-19 have a significant positive impact of VIX, VXD, and VXN; however, the S&P 500, DJIA, and NASDAQ 100 show a negative association. Again, we also observe the significant impact of COVID-19 in stock trading prices and volatility expectations. The evidence of the point forecasts is more reliable for European IV indices than the US IV indices. Finally, this study validates IV indices' informational efficiency in the financial markets and suggests investors about portfolio management and investment risk minimization for similar future pandemic situations.

Love Thy Neighbor? Perceived Community Abidance and Private Compliance to COVID-19 Norms in India
Upasak Das,Prasenjit Sarkhel,Sania Ashraf

Compliance with measures like social distancing, hand-washing and wearing masks have emerged as the dominant strategy to combat health risk from the COVID-19 pandemic. These behaviors are often argued to be pro-social, where one must incur private cost to benefit or protect others. Using self-reported data across India (n=934) through online survey, we assess if changes in perceived community compliance can predict changes in individual compliance behavior, controlling for the potential confounders. We observe statistically significant and positive relationship between the two, even after accounting for omitted variable bias, plausibly allowing us to view the results from a plausible causal lens. Further, we find subsequent lockdowns such as the ones imposed in India, have a detrimental effect on individual compliance though the gains from higher perceived community compliance seems to offset this loss. We also find that sensitization through community can be particularly effective for people with pre-existing co-morbidities. Our findings underscore the need for multi-level behavioral interventions involving local actors and community institutions to sustain private compliance during the pandemic.

Model of continuous random cascade processes in financial markets
Jun-ichi Maskawa,Koji Kuroda

This article present a continuous cascade model of volatility formulated as a stochastic differential equation. Two independent Brownian motions are introduced as random sources triggering the volatility cascade. One multiplicatively combines with volatility; the other does so additively. Assuming that the latter acts perturbatively on the system, then the model parameters are estimated by application to an actual stock price time series. Numerical calculation of the Fokker--Planck equation derived from the stochastic differential equation is conducted using the estimated values of parameters. The results reproduce the pdf of the empirical volatility, the multifractality of the time series, and other empirical facts.

Modeling the US-China trade conflict: a utility theory approach
Yuhan Zhang,Cheng Chang

This paper models the US-China trade conflict and attempts to analyze the (optimal) strategic choices. In contrast to the existing literature on the topic, we employ the expected utility theory and examine the conflict mathematically. In both perfect information and incomplete information games, we show that expected net gains diminish as the utility of winning increases because of the costs incurred during the struggle. We find that the best response function exists for China but not for the US during the conflict. We argue that the less the US coerces China to change its existing trade practices, the higher the US expected net gains. China's best choice is to maintain the status quo, and any further aggression in its policy and behavior will aggravate the situation.

On the impact of publicly available news and information transfer to financial markets
Metod Jazbec,Barna Pásztor,Felix Faltings,Nino Antulov-Fantulin,Petter N. Kolm

We quantify the propagation and absorption of large-scale publicly available news articles from the World Wide Web to financial markets. To extract publicly available information, we use the news archives from the Common Crawl, a nonprofit organization that crawls a large part of the web. We develop a processing pipeline to identify news articles associated with the constituent companies in the S\&P 500 index, an equity market index that measures the stock performance of U.S. companies. Using machine learning techniques, we extract sentiment scores from the Common Crawl News data and employ tools from information theory to quantify the information transfer from public news articles to the U.S. stock market. Furthermore, we analyze and quantify the economic significance of the news-based information with a simple sentiment-based portfolio trading strategy. Our findings provides support for that information in publicly available news on the World Wide Web has a statistically and economically significant impact on events in financial markets.

Optimal Signal-Adaptive Trading with Temporary and Transient Price Impact
Eyal Neuman,Moritz Voß

We study optimal liquidation in the presence of linear temporary and transient price impact along with taking into account a general price predicting finite-variation signal. We formulate this problem as minimization of a cost-risk functional over a class of absolutely continuous and signal-adaptive strategies. The stochastic control problem is solved by following a probabilistic and convex analytic approach. We show that the optimal trading strategy is given by a system of four coupled forward-backward SDEs, which can be solved explicitly. Our results reveal how the induced transient price distortion provides together with the predictive signal an additional predictor about future price changes. As a consequence, the optimal signal-adaptive trading rate trades off exploiting the predictive signal against incurring the transient displacement of the execution price from its unaffected level. This answers an open question from Lehalle and Neuman [27] as we show how to derive the unique optimal signal-adaptive liquidation strategy when price impact is not only temporary but also transient.

Optimal per-loss reinsurance and investment to minimize the probability of drawdown
Xia Han,Zhibin Liang

In this paper, we study an optimal reinsurance-investment problem in a risk model with two dependent classes of insurance business, where the two claim number processes are correlated through a common shock component. We assume that the insurer can purchase per-loss reinsurance for each line of business and invest its surplus in a financial market consisting of a risk-free asset and a risky asset. Under the criterion of minimizing the probability of drawdown, the closed-form expressions of the optimal reinsurance-investment strategy and the corresponding value function are obtained. We show that the optimal reinsurance strategy is in the form of pure excess-of-loss reinsurance strategy under the expected value principle, and under the variance premium principle, the optimal reinsurance strategy is in the form of pure quota-share reinsurance. Furthermore, we extend our model to the case where the insurance company involves $n$ $(n\geq3)$ dependent classes of insurance business and the optimal results are derived explicitly as well.

Option Hedging with Risk Averse Reinforcement Learning
Edoardo Vittori,Michele Trapletti,Marcello Restelli

In this paper we show how risk-averse reinforcement learning can be used to hedge options. We apply a state-of-the-art risk-averse algorithm: Trust Region Volatility Optimization (TRVO) to a vanilla option hedging environment, considering realistic factors such as discrete time and transaction costs. Realism makes the problem twofold: the agent must both minimize volatility and contain transaction costs, these tasks usually being in competition. We use the algorithm to train a sheaf of agents each characterized by a different risk aversion, so to be able to span an efficient frontier on the volatility-p\&l space. The results show that the derived hedging strategy not only outperforms the Black \& Scholes delta hedge, but is also extremely robust and flexible, as it can efficiently hedge options with different characteristics and work on markets with different behaviors than what was used in training.

Supporting Tool for The Transition of Existing Small and Medium Enterprises Towards Industry 4.0
Miguel Baritto,Md Mashum Billal,S. M. Muntasir Nasim,Rumana Afroz Sultana,Mohammad Arani,Ahmed Jawad Qureshi

The rapid growth of Industry 4.0 technologies such as big data, cloud computing, smart sensors, machine learning (ML), radio-frequency identification (RFID), robotics, 3D-printing, and Internet of Things (IoT) offers Small and Medium Enterprises (SMEs) the chance to improve productivity and efficiency, reduce cost and provide better customer experience, among other benefits. The main purpose of this work is to propose a methodology to support SMEs managers in better understanding the specific requirements for the implementation of Industry 4.0 solutions and the derived benefits within their firms. A proposed methodology will be helpful for SMEs manager to take a decision regarding when and how to migrate to Industry 4.0.

The mitigating role of regulation on the concentric patterns of broadband diffusion. The case of Finland
Jaume Benseny,Juuso Töyli,Heikki Hämmäinen,Andrés Arcia-Moret

This article analyzes the role of Finnish regulation in achieving the broadband penetration goals defined by the National Regulatory Authority. It is well known that in the absence of regulatory mitigation the population density has a positive effect on broadband diffusion. Hence, we measure the effect of the population density on the determinants of broadband diffusion throughout the postal codes of Finland via Geographically Weighted Regression. We suggest that the main determinants of broadband diffusion and the population density follow a spatial pattern that is either concentric with a weak/medium/strong strength or non-concentric convex/concave. Based on 10 patterns, we argue that the Finnish spectrum policy encouraged Mobile Network Operators to satisfy ambitious Universal Service Obligations without the need for a Universal Service Fund. Spectrum auctions facilitated infrastructure-based competition via equitable spectrum allocation and coverage obligation delivery via low-fee licenses. However, state subsidies for fiber deployment did not attract investment from nationwide operators due to mobile preference. These subsidies encouraged demand-driven investment, leading to the emergence of fiber consumer cooperatives. To explain this emergence, we show that when population density decreases, the level of mobile service quality decreases and community commitment increases. Hence, we recommend regulators implementing market-driven strategies for 5G to stimulate local investment. For example, by allocating the 3.5 GHz and higher bands partly through local light licensing.

Trade-offs and synergies in managing coastal flood risk: A case study for New York City
Robert L. Ceres,Chris E. Forest,Klaus Keller

Decisions on how to manage future flood risks are frequently informed by both sophisticated and computationally expensive models. This complexity often limits the representation of uncertainties and the consideration of strategies. Here, we use an intermediate complexity model framework that enables us to analyze a rich set of strategies, objectives, and uncertainties. We find that allowing for more combinations of risk mitigation strategies can expand the solution set, help explain synergies and trade-offs, and point to strategies that can improve outcomes.

Trends in Corporate Borrowing
Berg, Tobias,Saunders, Anthony ,Steffen, Sascha
Corporate borrowing has substantially changed over the last two decades. In this paper, we investigate changes in borrowing of U.S. publicly listed firms along trends in five key areas: (1) the funding mix of firms and the importance of balance-sheet versus off-balance-sheet borrowing; (2) the costs of corporate borrowing; (3) trends in non-price loan terms; (4) the importance of banks vs- non-bank institutional investors; and (5) the purpose for corporate borrowing. We explore these trends graphically over the 2002 to 2019 period, provide a narrative for these trends based on the theoretical and empirical literature in the respective areas, and discuss some implications for the current COVID-19 pandemic. We finally document these trends for firms in the Eurozone countries and delineate similarities and differences.

Who Benefits from Analyst “Top Picks”?
Birru, Justin,Gokkaya, Sinan,Liu, Xi,Stulz, René M.
Following the Global Settlement, analysts extensively use a top pick designation to highlight their highest conviction best ideas. Such a designation enables analysts to provide greater granularity of information, but it can potentially be influenced by conflicts of interest. Examining a comprehensive sample of top picks, we find, even though top picks are more likely to be investment banking clients, they have greater investment value, attract greater media and investor attention, and lead to more trading. Top picks with poor ex post investment value are more likely to be influenced by strategic objectives and have adverse consequences for analysts. Institutions, but not retail investors, discern between top picks with good and poor ex post investment value.