Research articles for the 2020-10-30

Back to Basis: A Universal Return Predictor Across Asset Classes
Molyboga, Marat
This paper shows analytically that the basis between spot and futures contracts contains information about future returns of securities across the asset classes of commodities, equity indices, fixed income and foreign exchange. The bases in commodities are positively correlated with a leading indicator of the business cycle whereas the bases in the financial assets are negatively related to the short-term rate. The return predictability of the basis can be captured with a simple multi-asset long-short strategy which produces an out-of-sample Sharpe ratio of 0.5 and an alpha of 2.5%-4.5% per annum with respect to commonly used asset pricing models. Specifically, the analysis includes five Fama-French Factors, a bond index and futures risk premia of multi-asset momentum, value, time-series momentum, and four asset-specific carry factors. The strategy performance is counter-cyclical and robust to transaction costs.

Benchmark-Driven Investments in Emerging Market Bond Markets: Taking Stock
Arslanalp, Serkan,Drakopoulos, Dimitris,Goel, Rohit,Koepke, Robin
This paper reviews the role of benchmark-driven investments in EM local bond markets. We provide an overview of how key EM bond benchmark indices are constructed, how they affect the behavior of investment funds, and what are the likely implications for capital flows and policy-making. Several methods are presented suggesting that the amount of assets benchmarked against widely followed EM local-currency bond indices have risen fivefold since the mid-2000s to around $300 billion. Our review suggests that the benefits of index membership may be tempered by portfolio outflow risks for some countries. This is because benchmark-driven investments may increase the importance of external factors at the expense of domestic factors, raising the risks of outflows unrelated to recipient country fundamentals. Some countries may be disproportionately exposed to these risks, reflecting the way the indices are constructed.

Beyond the COVID-19 Crisis: A Framework for Sustainable Government-to-Person Mobile Money Transfers
Davidovic, Sonja,Nunhuck, Soheib,Prady, Delphine,Tourpe, Hervé
During the 2020 pandemic, the majority of countries have provided income support to households at an unprecedented speed and scale. Social distancing measures and the large penetration of mobile phones in emerging markets and developing economies (EMDEs) have encouraged government-to-person (G2P) transfers through mobile platforms. This paper presents a comprehensive framework for sustainable money solutions in support of social assistance. The framework consists of eight building blocks that may help policymakers i) take stock and assess emergency fixes taken to scale up mobile money in a crisis context and ii) develop sustainable long-term solutions for mobile G2P transfers.

Capital Flow Data - a Guide for Empirical Analysis and Real-Time Tracking
Paetzold, Simon
This paper provides an analytical overview of the most widely used capital flow datasets. The paper is written as a guide for academics who embark on empirical research projects and for policymakers who need timely information on capital flow developments to inform their decisions. We address common misconceptions about capital flow data and discuss differences between high-frequency proxies for portfolio flows. In a nowcasting 'horse race' we show that high-frequency proxies have significant predictive content for portfolio flows from the balance of payments (BoP). We also construct a new dataset for academic use, consisting of monthly portfolio flows broadly consistent with BoP data.

Coordinating Revenue Incentive Policies in the Caribbean
Ding, Ding,Kalla, Samira,Rosales Torres, Manuel,Sidibé, Abdoul Karim
The pervasive use of tax incentives is costly for the Caribbean countries, yet the benefits seem limited. Better policy coordination at the regional level is needed to help overcome the collective action problems and generate more revenue to support the much-needed infrastructure investment. Using the region's Citizenship-by-Investment (CBI) programs as an example, we also show that a price-quantity coordination mechanism can help achieve an efficient outcome with greater CBI incomes for member countries.

Do FX Interventions Lead to Higher FX Debt? Evidence from Firm-Level Data
Kim, Minsuk,Mano, Rui,Mrkaic, Mico
Central banks often buy or sell reserves---so called FX interventions (FXIs)---to dampen sharp exchange rate movements caused by volatile capital flows. At the same time, these interventions may entail unintended side effects. In this paper, we investigate whether FXIs incentivize firms to take on more unhedged FX debt, thereby increasing medium-term corporate vulnerabilities. Using a novel dataset with close to 5,000 nonfinancial firms across 19 emerging markets covering 2002--2017, we find that the firm-level share of FX debt rises following intensive use of FXIs, particularly for non-exporting firms in shallow financial markets with no FX debt to begin with. The magnitude of this effect is economically significant, with one standard deviation increase in FXI leading to an average 2 percentage points increase in the FX debt share. For reference, the median share of FX debt in the sample is zero.

Exchange Rates and Domestic Credit-Can Macroprudential Policy Reduce the Link?
Nier, Erlend,Olafsson, Thorvardur Tjoervi,Rollinson, Yuan Gao
This paper examines empirically the role of macroprudential policy in addressing the effects of external shocks on financial stability. In a sample of 62 economies over the period of 2000: Q1-2016: Q4, our dynamic panel regressions show that an appreciation of the local exchange rate is associated with a subsequent increase in the domestic credit gap, while a prior tightening of macroprudential policies dampens this effect. These results are strong for small open economies, and robust when we explicitly account for potential simultaneity and reverse causality biases. We also examine a feedback effect where strong domestic credit pulls in additional cross-border funding, potentially further increasing systemic risk, and find that targeted capital controls can play a complementary role in alleviating this effect.

FinTech Adoption and Household Risk-Taking
Hong, Claire Yurong ,Lu, Xiaomeng,Pan, Jun
This paper examines how FinTech can lower investment barriers and help households move toward optimal risk-taking, using a unique account-level data on consumption, investments, and FinTech usage from Ant Group. During our sample period, China experienced a rapid increase in FinTech penetration in the form of offline digital payment, and our measure of FinTech adoption is constructed relative to this fast-developing trend of new technology. Taking advantage of our consumption data, we further infer individuals’ risk tolerance from their consumption volatility. We find that, while FinTech adoption improves risk-taking for all, the more risk-tolerant individuals benefit more from FinTech advancement. The magnitude of FinTech improvement is further quantified relative to the optimal alignment of risk-taking and consumption prescribed by Merton (1971). Aggregating to the city-level, we fi nd significant variations in FinTech adoption across cities in China, owing to the gradual spread of the new technology from Hangzhou to inner China. Examining the enhancement in risk-taking across geographical locations, we find that cities with low financial-service coverage benefit the most from FinTech penetration. Overall, our results show that, by unshackling the traditional constraints, FinTech improves risk-taking for individuals who need it the most.

Financial Amplification of Labor Supply Shocks
Biljanovska, Nina,Vardoulakis, Alexandros
We study how financial frictions amplify labor supply shocks in a macroeconomic model with occasionally binding financing constraints. Workers supply labor to entrepreneurs who borrow to purchase factors of production. Borrowing capacity is restricted by the value of capital, generating a pecuniary externality when financing constraints bind. Additionally, there is a distributive externality operating through wages. The planner's allocation can be decentralized with two instruments: a credit tax/subsidy and a labor tax/subsidy. Labor shocks, such as the COVID-19 shock, amplify the policy responses, which critically depend on whether financing constraints bind or not.

Fintech Credit Risk Assessment for SMEs: Evidence from China
Huang, Yiping,Zhang, Longmei,Li, Zhenhua,Qiu, Han,Sun, Tao,Wang, Xue
Promoting credit services to small and medium-size enterprises (SMEs) has been a perennial challenge for policy makers globally due to high information costs. Recent fintech developments may be able to mitigate this problem. By leveraging big data or digital footprints on existing platforms, some big technology (BigTech) firms have extended short-term loans to millions of small firms. By analyzing 1.8 million loan transactions of a leading Chinese online bank, this paper compares the fintech approach to assessing credit risk using big data and machine learning models with the bank approach using traditional financial data and scorecard models. The study shows that the fintech approach yields better prediction of loan defaults during normal times and periods of large exogenous shocks, reflecting information and modeling advantages. BigTech's proprietary information can complement or, where necessary, substitute credit history in risk assessment, allowing unbanked firms to borrow. Furthermore, the fintech approach benefits SMEs that are smaller and in smaller cities, hence complementing the role of banks by reaching underserved customers. With more effective and balanced policy support, BigTech lenders could help promote financial inclusion worldwide.

Liquidation Cascade and Hedging Front-Running: Evidence from the Structured Equity Product Market
Auh, Jun Kyung,Cho, Wonho
We show that structured equity derivatives could cause a significant price dislocation of the underlying stock caused by an abrupt delta-hedging triggered by a predefined event in the payoff. Moreover, one event causes another: the cascade of event-driven liquidation amplifies the magnitude of the market impact. We find that a single liquidation event is associated with about -4% return on the event day. The non-informational price shock increases, in turn, the probability of a subsequent event by 15.7%. Given the negative price pressure, traders try to liquidate ahead of each other, exacerbating the degree of price dislocation. Our results reveal the chain-reaction mechanism and (mis)coordination device in complex derivatives markets that could provoke a substantial stock-price deviations.

Market Power, Growth, and Inclusion: The South African Experience
Thakoor, Vimal
Before the pandemic, the South African economy remained stuck in low gear, with anemic growth, stagnant private investment, and a shrinking tradable sector. Subdued growth has raised unemployment, poverty, and inequality, hindering inclusion efforts. The pandemic has worsened economic and social vulnerabilities. Economic recovery and social inclusion hinge critically on structural reforms to boost competiveness and growth. Product markets represent a cornerstone of the reform strategy. Firms have used their market power to drive up prices and limit competition. Important state-owned monopolies provide low-quality services, while representing a fiscal drag. Existing regulations inhibit the entry of both domestic and foreign firms. Addressing product markets constraints could boost per capita growth by 1 percentage point-adding about 21/2 percentage points to headline growth-and foster greater inclusion.

Monetary Policy Under an Exchange Rate Anchor
El Hamiani Khatat, Mariam,Buessings-Loercks, Mark,Fleuriet, Vincent
This paper argues that there is scope for monetary policy under an exchange rate anchor, and discusses the related monetary policy design and implementation. It shows that the exchange rate can be used as the main monetary policy instrument while the policy rate can target the exchange rate. An exchange rate anchor is compatible with an inflation objective, provided fiscal dominance is not an issue, monetary conditions are supportive of the peg, and the level of international reserves is adequate. The paper argues that, while an exchange rate anchor is more prone to policy inconsistencies, there is ample scope for strengthening monetary policy design and implementation under soft pegs. In that context, the principles of dichotomy and interest rate parity are critical.

Non-Primary Home Buyers, Shadow Banking, and the US Housing Market
Alter, Adrian,Dernaoui, Zaki
This paper studies the US housing market using a proprietary and comprehensive dataset covering nearly 90 million residential transactions over 1998-2018. First, we document the evolution of different types of investment purchases such as those conducted by short-term buyers, out-of-state buyers, and corporate cash investors. Second, we quantify the contributions of non-primary home buyers to the housing cycle. Our findings suggest that the share of short-term investors grew substantially in the run-up to the global financial crisis (GFC), which amplified the boom-bust cycle, while out-of-state buyers propped up prices in some areas during the recession. An instrumental variable approach is employed to establish a causal relationship between housing investors and prices. Finally, we show that the recent rise of shadow bank lending in the residential market is associated with riskier mortgages, and explore its implications for non-primary home buyers and its effects on house prices and rents.

Offshore Currency Markets: Non-Deliverable Forwards (NDFs) in Asia
Schmittmann, Jochen,Teng, Chua Han
Non-deliverable forward (NDF) markets in many Asian emerging market currencies are large, rapidly growing, and often exceed onshore markets in transaction volume. NDFs tend to price significant depreciation during market stress episodes including COVID-19. Spillovers from NDFs to onshore markets are a policymaker concern. Our analysis shows that influences tend to run both ways after controlling for differences in timezones between markets. For the COVID-19 pandemic there is some evidence of NDFs leading onshore markets for a few currencies. Policy approaches to NDFs vary widely across Asia from close integration with onshore markets to severe restrictions on NDF trading.

Reducing Risk While Sharing it: A Fiscal Recipe for the EU at the Time of COVID-19
Batini, Nicoletta,Lamperti, Francesco,Roventini, Andrea
The COVID-19 lockdowns have brought about the need of large fiscal responses in all European countries. However, countries across Europe are differently equipped to respond to the shock due to differences in economic conditions and fiscal space. We build on the model by Berger et al. (2019) to compare gains from alternative mechanisms of EU fiscal integration in the presence of moral hazard. We show that any EU response strategy to the COVID-19 crisis excluding mutual financial support to member countries lacks credibility. Some form of fiscal risk sharing is indeed better than none, especially in presence of increasing sovereign default risk of some EU member countries. The moral hazard created by risk sharing can be hedged by introducing some form of fiscal delegation to Brussels. The desirable level of delegation, however, depends on its costs. When these are low, risk sharing and delegation are substitutes and it is optimal to opt for high delegation and low risk sharing. On the contrary, when delegation costs are high, centralization and risk sharing are complements and both are needed. Proposed arrangements at the EU level in response to the COVID-19 shock seem to reflect these basic insights by rotating around a combination of fiscal risk sharing and delegation in the form of fiscal spending conditionality.

Sentiment Augmented Supply and Demand Equations for the Dry Bulk Shipping Market
Melas, Konstantinos (Kostis),Michail, Nektarios
We present, for the first time in the literature, empirical estimates of the supply and demand curves for the ocean-going dry bulk sector, using a three-stage least squares methodology. Furthermore, we augment these functions with sentiment, which appears to have a positive and significant impact on supply. This supports the view that the outlook shipowners have about the market will undoubtedly influence their decisions regarding purchasing vessels or bringing them out of lay ups. Thus, our results highlight the fact that future expectations have an impact on the current pricing, albeit indirectly through their impact on the supply side. Our results further enhance the behavioral economics literature and provide important insights for both academics and professionals.

Sovereign Investor Relations: From Principles to Practice
Knight, James,Northfield, Bill
This paper defines sovereign investor relations (IR) and places it in the context of modern debt management theory. It highlights the role that improvements in IR and debt transparency can play in improving the cost-risk tradeoff in debt management, supporting market access and acting as a first line of defense in times of crisis. It sets out a policy framework and institutional arrangements for effective IR, as well as discussing the various practices, publications and strategies that underpin an IR program.

Structural Changes in Japanese Firms: Business Dynamism in an Aging Society
Hong, Gee Hee,Ito, Arata,Saito, Yukiko Umeno,Nguyen, Anh Thi Ngoc
The COVID-19 pandemic has posed a serious threat to the survival of Japanese firms, highlighting the importance of understanding how and why firms exit. In this paper, we use a rich firm-level dataset of Japanese firms to document how firm exit patterns have evolved between 2007 and 2017. Firm exit patterns have been heavily influenced by Japan's demographic trends, as a majority of exits in recent years were voluntary exits of firms (business closures) owned by CEOs aged 65 years or older without business successors. In contrast to this increase in voluntary exits, other 'traditional' firm exits (such as bankruptcies), have declined. These findings underscore the importance of addressing business transition issues in a rapidly aging society.

Tackling Private Over-Indebtedness in Asia: Economic and Legal Aspects
Nadeem, Sanaa,Riad, Nagwa,Rosha, Anjum,DeLong, Chanda,Rendak, Nadia
One consequence of interest rates remaining 'too low for too long' since the Global Financial Crisis is the buildup in private leverage in emerging economies. These vulnerabilities have been laid bare by the COVID-19 shock. This paper employs the growth at risk framework (Adrian, Boyarchenko, and Giannone, 2019) to examine how different types of private leverage present risks to future GDP growth in Asian economies. We find evidence that private leverage can boost GDP growth in the near term, but can increase the risks of low growth over the medium term. For our sample, we also find that household debt poses a larger drag on future GDP growth than corporate debt. In the second part of the paper, we provide an overview of a strategy for prevention and resolution of over-indebtedness, with a focus on legal tools, and with considerations to account for the consequences of the COVID-19 pandemic. Using a novel cross-country survey, we examine the role of legal techniques to prevent and treat corporate and household over-indebtedness, benchmarking those in ASEAN-5, China, India, Japan and Korea against international best practice. The analysis can inform a country-specific prioritized approach to strengthening legal frameworks.

The Fiscal Multiplier of Public Investment: The Role of Corporate Balance Sheet
Espinoza, Raphael,Gamboa-Arbelaez, Juliana,Sy, Mouhamadou
This paper explores whether public investment crowds out or crowds in private investment. To this aim, we build a database of about half a million firms from 49 countries. We find that the effect of public investment on corporate investment depends both on leverage and financial constraints. Public investment boosts private investment for firms with low leverage. However, for firms with high leverage, private investment does not react to an increase in public investment, in line with theory (Myers 1977). We also find that the effect of public investment on corporate investment is much weaker for firms that are financially constrained.

What Drives Bank Lending Spreads and Collateral Requirements in the Kyrgyz Republic
Ruxandra Teodoru, Iulia
Limited access to finance and its high cost have contributed to relatively low levels of private investment and subpar growth in the Kyrgyz Republic. Interest rate spreads have moderated in recent years, but remain high from both a regional and global perspective. At the same time, collateral requirements applied by banks are onerous and also constrain the quantity of credit supplied. This paper identifies a range of factors that could lower spreads in the Kyrgyz Republic: more competition, higher capital, lower credit risk, larger loan size, lower deposit rates and external funding costs, as well as a stronger legal framework. Lower operating costs appear critical to reduce relatively higher spreads for small and medium-sized banks. At the same time, a stronger legal framework and greater transparency on borrowers' creditworthiness would help reduce the high collateral requirements. Reforms in all these areas would support greater financial inclusion in the aftermath of the pandemic, and could thus be a key source of sustainable and inclusive growth in the Kyrgyz Republic.