Research articles for the 2020-11-23

A Framework for Conceptualizing Islamic Bank Socialization in Indonesia
Suryo Budi Santoso,Herni Justiana Astuti

The purpose of this study is the design model of Islamic bank socialization in terms of four pillars (Business Institution, Formal Education, Islamic Scholar and Higher Education) through Synergy and Proactive. The location of the study was conducted in the Regency of Banyumas, Indonesia. The results of the survey on respondents obtained 145 respondents' answers that deserve to be analyzed. Data were analyzed using SEM models with Partial Least Squares approach, designing measurement models (outer models) and designing inner models. The results of the calculation outside the model of all measurements are more than the minimum criteria required by removing Formal Education from the model because it does not meet the requirements. While the inner model results show that the socialization model was only built by the Business Institution, Islamic Scholar and Higher Education through synergy and proactivity. All independent variables directly influence the dependent variable, while the intervening variables also significantly influence except the relationship of Islamic Scholar Islamic to Bank Socialization through Proactive.

A Novel Classification Approach for Credit Scoring based on Gaussian Mixture Models
Arian, Hamidreza,Seyfi, Seyed Mohammad Sina,Sharifi, Azin
Credit scoring is a rapidly expanding analytical technique used by banks and other financial institutions. Academic studies on credit scoring provide a range of classification techniques used to differentiate between good and bad borrowers. The main contribution of this paper is to introduce a new method for credit scoring based on Gaussian Mixture Models. Our algorithm classifies consumers into groups which are labeled as positive or negative. Labels are estimated according to the probability associated with each class. We apply our model with real world databases from Australia, Japan, and Germany. Numerical results show that not only our model's performance is comparable to others, but also its flexibility avoids over-fitting even in the absence of standard cross validation techniques. The framework developed by this paper can provide a computationally efficient and powerful tool for assessment of consumer default risk in related financial institutions.

Adverse Scale Effect and Managerial Skill in Mutual Funds: Evidence from Corporate Bond Mutual Funds
Khorram, Mehdi
This paper examines a sample of corporate bond mutual funds to explore the presence of a decreasing returns to scale effect among mutual funds. Initial results show that on average, fund performance decreases by 13.85 basis points per year when the fund size increases by one standard deviation. The negative and significant relation between fund performance and fund size persists when various robustness tests are conducted. Further results show that the negative effect of scale on performance is related to illiquidity effects, since performance of mutual funds that hold high yield bonds â€" the least liquid bonds â€" decreases by a factor of ten times the performance of other funds as size increases. Given the adverse effect of size on performance, we reevaluate the fund manager’s skill. Unlike the common belief that fund managers are not skilled on average, our results indicate that corporate bond mutual fund managers are skilled. Finally, by sorting managers based on their skills, we find that highly skilled managers persistently generate more than 2 million dollars per month for up to 12 months into the future. It implies that a manager’s skill is persistent, and performance is not attributable to luck.

Analysis of Insolvency Proceedings in Spain Against the Backdrop of the Covid-19 Crisis: Insolvency Proceedings, Pre-Insolvency Arrangements and the Insolvency Moratorium
García-Posada, Miguel
The inefficiency of Spanish insolvency proceedings â€" evidenced by their length and reflected in the fact that non-financial corporations and sole proprietors make limited use of both insolvency proceedings and pre-insolvency arrangements â€" is a structural shortcoming of the Spanish economy. It is a problem that has become particularly important against the backdrop of the COVID-19 crisis and the severe impact it is having on the financial situation of Spanish firms, despite the broad range of public measures introduced to mitigate it. This document analyses the functioning of the insolvency system, examines the pros and cons of the insolvency moratorium currently in place and proposes various alternatives that could make the system more efficient when the moratorium expires at the end of the year.

Assessing Systemic Risk in the Insurance Sector via Network Theory
Gian Paolo Clemente,Alessandra Cornaro

We provide a framework for detecting relevant insurance companies in a systemic risk perspective. Among the alternative methodologies for measuring systemic risk, we propose a complex network approach where insurers are linked to form a global interconnected system. We model the reciprocal influence between insurers calibrating edge weights on the basis of specific risk measures. Therefore, we provide a suitable network indicator, the Weighted Effective Resistance Centrality, able to catch which is the effect of a specific vertex on the network robustness. By means of this indicator, we assess the prominence of a company in spreading and receiving risk from the others.

Asset Allocation via Machine Learning and Applications to Equity Portfolio Management
Qing Yang,Zhenning Hong,Ruyan Tian,Tingting Ye,Liangliang Zhang

In this paper, we document a novel machine learning based bottom-up approach for static and dynamic portfolio optimization on, potentially, a large number of assets. The methodology applies to general constrained optimization problems and overcomes many major difficulties arising in current optimization schemes. Taking mean-variance optimization as an example, we no longer need to compute the covariance matrix and its inverse, therefore the method is immune from the estimation error on this quantity. Moreover, no explicit calls of optimization routines are needed. Applications to equity portfolio management in U.S. and China equity markets are studied and we document significant excess returns to the selected benchmarks.

Bubble Sentiment
Li, Gen
I examine the difference in news sentiment between stock price run-ups that crash (bubble stocks) and do not crash (non-bubble stocks). I find that bubble stocks have more negative sentiment in earnings news during their run-ups. The negative sentiment has predictive power up to two years in advance that a run-up is a bubble and will crash. I do not observe similar predictability from positive earnings news or news unrelated to earnings. I find that past negative sentiment in earnings news also predicts a bubble’s future maximum drawdown.

Callable or Convertible Debt? The Role of Debt Overhang and Covenants
Flor, Christian Riis,Petersen, Kirstine Boye,Schandlbauer, Alexander
Many U.S. corporate bonds are either callable or convertible. While callable bonds provide a higher coupon to bondholders in exchange for a firm's repurchase option of its claim, convertible bonds offer investors the option to exchange a firm's debt to equity. This paper analyzes the choice between these two debt contracts. Using a dynamic capital structure theory model that includes an investment choice, we show that firms which are more exposed to debt overhang issue callable rather than convertible bonds. Convertible bonds are preferred if the firm has a higher initial level of debt. However, if bonds have covenants attached, the firm is more likely to issue callable bonds. Our empirical findings support the theory.

Capital (Mis)allocation and Incentive Misalignment
Schramm, Alexander,Schwemmer, Alexander Horst,Schymik, Jan
This paper studies how the allocation of capital within firms is shaped by short-termist incentives. We first present empirical evidence on the existence of a within-firm capital (mis)allocation channel caused by distortions of managerial incentives. Using the reform of the FAS 123 accounting statement in the U.S. as a quasi-natural experiment and within-firm variation across investments with different durabilities, we find that firms systematically shifted expenditures towards less durable investments in response to a shift towards more short-term incentives. This reform-induced alteration of the firm-specific capital mix effectively shortened the durability of firms' capital stock. By calibrating a dynamic model of firm investments in which managers determine investment policies, we then seek to quantify the economic impact of such incentive distortions on output, investment and capital (mis)allocation. In our model, bonus-equity incentive contracts induce managers to make quasi-hyperbolic investment decisions and raise differences in the marginal products of capital goods. Relatively small deviations in incentives induced by the accounting reform caused substantial distortions within and across firms. Overall, the reform-induced shift in capital structures away from the social optimum lowered long-run profits by about 0.54% on average.

Continuous-Time Risk Contribution and Budgeting for Terminal Variance
Mengjin Zhao,Guangyan Jia

Seeking robustness of risk among different assets, risk-budgeting portfolio selections have become popular in the last decade. Aiming at generalizing risk budgeting method from single-period case to the continuous-time, we characterize the risk contributions and marginal risk contributions on different assets as measurable processes, when terminal variance of wealth is recognized as the risk measure. Meanwhile this specified risk contribution has a aggregation property, namely that total risk can be represented as the aggregation of risk contributions among assets and $(t,\omega)$. Subsequently, risk budgeting problem that how to obtain the policy with given risk budget in continuous-time case, is also explored which actually is a stochastic convex optimization problem parametrized by given risk budget. Moreover single-period risk budgeting policy is related to the projected risk budget in continuous-time case. Based on neural networks, numerical methods are given in order to get the policy with a specified budget process.

Corporate Social Responsibility and Litigation Risk
Boyer, M. Martin,Kordonsky, Ksenia
Litigation is costly to firms, and so is, allegedly, corporate social responsibility (CSR) activities. This paper investigates whether CSR helps reduce a firm's class-action securities litigation risk. We hypothesize that firms strategically invest in CSR to build moral capital to reduce the probability of securities litigation. Correcting for the endogeneity of CSR activities, we find robust evidence that CSR reduces the probability that a firm faces securities class-action lawsuits. Furthermore, we show that a higher CSR score reduces the size of the abnormal market reaction following the revelation of suspected fraud. These findings suggest that strategic philanthropy increases (or at least preserves) firm wealth by reducing the costs related to securities litigation.

Deep Learning, Predictability, and Optimal Portfolio Returns
Mykola Babiak,Jozef Barunik

We study dynamic portfolio choice of a long-horizon investor who uses deep learning methods to predict equity returns when forming optimal portfolios. Our results show statistically and economically significant benefits from using deep learning to form optimal portfolios through certainty equivalent returns and Sharpe ratios. Return predictability via deep learning also generates substantially improved portfolio performance across different subsamples, particularly during recessionary periods. These gains are robust to including transaction costs, short-selling and borrowing constraints.

Discrete time multi-period mean-variance model: Bellman type strategy and Empirical analysis
Shuzhen Yang

In this paper, we attempt to introduce the Bellman principle for a discrete time multi-period mean-variance model. Based on this new take on the Bellman principle, we obtain a dynamic time-consistent optimal strategy and related efficient frontier. Furthermore, we develop a varying investment period discrete time multi-period mean-variance model and obtain a related dynamic optimal strategy and an optimal investment period. This paper compares the highlighted dynamic optimal strategies of this study with the 1/n equality strategy, and shows that we can secure a higher return with a smaller risk based on the dynamic optimal strategies.

Effect of Long-Term Debt on the Financial Growth of Non-Financial Firms Listed at the Nairobi Securities Exchange
David Haritone Shikumo,Oluoch Oluoch,Joshua Matanda Wepukhulu

A significant number of the non-financial firms listed at Nairobi Securities Exchange (NSE) have been experiencing declining financial performance which deter investors from investing in such firms. The lenders are also not willing to lend to such firms. As such, the firms struggle to raise funds for their operations. Prudent financing decisions can lead to financial growth of the firm. The purpose of this study is to assess the effect of Long-term debt on the financial growth of Non-financial firms listed at Nairobi Securities Exchange. Financial firms were excluded because of their specific sector characteristics and stringent regulatory framework. The study is guided by Trade-Off Theory and Theory of Growth of the Firm. Explanatory research design was adopted. The population of the study comprised of 45 non-financial firms listed at the NSE for a period of ten years from 2008 to 2017. The study conducted both descriptive statistics analysis and panel data analysis. The result indicates that Long term debt explains 21.6% and 5.16% of variation in financial growth as measured by growth in earnings per share and growth in market capitalization respectively. Long term debt positively and significantly influences financial growth measured using both growth in earnings per share and growth in market capitalization. The study recommends that, the management of non-financial firms listed at Nairobi Securities Exchange to employ financing means that can improve the earnings per share, market capitalization and enhance the value of the firm for the benefit of its stakeholders.

Exchange-Traded Funds and Municipal Bond Market
Doan, Viet-Dung
This paper examines the effect of exchange-traded funds' (ETFs) information disclosure on the pricing and trading of municipal bonds. Bonds held by ETFs are found to have significantly smaller price dispersion than similar, non-ETF-held bonds. The effect is stronger for retail trades than for institutional trades, suggesting ETF holding disclosure brings about higher benefit for investors who lack information ex-ante. ETF-held bonds are also more liquid and associated with higher trading activity. Similar effect is documented in the primary market, as when a municipality has outstanding bonds held by ETFs, its newly issued bonds have lower yield, higher price, and lower price dispersion. Overall, my findings indicate that ETF holding disclosure is an important channel through which investors can gain additional insight into the pricing of municipal bonds.

Extrapolators at the Gate: Market-wide Misvaluation and the Value Premium
Cassella, Stefano,Chen, Zhaojing,Gulen, Huseyin,Petkova, Ralitsa
We develop a model of financial markets based on the idea that when extrapolators move capital in and out of the equity market, they disproportionately buy growth stocks in good times and sell value stocks in bad times. The model predicts that the cross-sectional value premium should be stronger following states of large market-wide over- or undervaluation due to extrapolative expectations. We test this prediction empirically and find strong support for it. The value premium is 3.42% per month following market-wide undervaluation and 1.70% per month following market overvaluation. In the remainder 60% to 80% of the sample, when the market is neither significantly over or under-valued, there is no significant value premium in a monthly horizon and the value premium is only 0.54% per month in an annual horizon. We provide extensive evidence that our results are driven by extrapolative expectations. Overall, this paper sheds new light on the source of the value premium and offers new support for extrapolation-based asset-pricing theories.

Fintech and Big Tech Credit: A New Database
Cornelli, Giulio,Frost, Jon,Gambacorta, Leonardo,Rau, P. Raghavendra,Wardrop, Robert,Ziegler, Tania
Fintech and big tech platforms have expanded their lending around the world. We estimate that the flow of these new forms of credit reached USD 223 billion and USD 572 billion in 2019, respectively. China, the United States and the United Kingdom are the largest markets for fintech credit. Big tech credit is growing fast in China, Japan, Korea, Southeast Asia and some countries in Africa and Latin America. Cross-country panel regressions show that such lending is more developed in countries with higher GDP per capita (at a declining rate), where banking sector mark-ups are higher and where banking regulation is less stringent. Fintech credit is larger where there are fewer bank branches per capita. We also find that fintech and big tech credit are more developed where the ease of doing business is greater, and investor protection disclosure and the efficiency of the judicial system are more advanced, the bank creditto-deposit ratio is lower and where bond and equity markets are more developed. Overall, alternative credit seems to complement other forms of credit, rather than substitute for them.

Fitting Gamma Mixture Density Networks with Expectation-Maximization Algorithm
Delong, Lukasz,Lindholm, Mathias,Wuthrich, Mario V.
We discuss how mixtures of Gamma distributions with shape and rate parameters depending on explanatory variables can be fitted with neural networks. We develop two versions of the EM algorithm for fitting Gamma Mixture Density Networks which we call the EM network boosting algorithm and the EM forward network algorithm. The key difference between the EM algorithms is how we pass the information about the trained neural networks and the predicted parameters between the iterations of the EM algorithm. We validate our EM algorithms and test different methods of how the algorithms can be efficiently applied in practice. Our algorithms work for general mixtures of any distribution types that have closed form densities.

Green banks vs. non-green banks: A Differences-in-Differences CAMEL-based approach
Malandrakis, Ioannis,Drakos, Konstantinos
The need for the transition from a high-carbon to a low-carbon economy has led to the creation of the so-called green banks, while many financial institutions around the world are gradually adjusting their loan portfolio to a greener one by financing environment-friendly projects. Using a panel data set of 165 global and non-global banks from 38 countries worldwide, covering the period 1999 â€" 2015, we examine whether there are any discernible performance differences between green and non-green banks. The variables of interest are fundamental CAMEL factors. By employing panel data techniques, we investigate whether there are statistically significant differences between the two groups. Moreover, we adopt the Differences-in-Differences approach to examine whether green banks (“treatment” group) and non-green banks (“control” group) exhibit differential behavior, and we use the financial crisis outbreak as the time of intervention. We find that both green and non-green banks are affected by nearly the same bank-specific factors and that they do not exhibit heterogeneous behavior with respect to several fundamental aspects. Specifically, our results show that green banks â€" whether global or not â€" perform better than their non-green counterparts only in terms of Total Capital Ratio and Tier1 Capital Ratio during and after the financial crisis. As for the rest of the CAMEL factors, it seems that both groups exhibit the same behavior, especially in the post-crisis period. In addition, our results indicate that the financial crisis has: (a) a positive effect on capital adequacy (excluding Leverage Ratio which seems to have remained unaffected), on asset quality and management quality; (b) a negative effect on earnings ability; (c) a negative impact on liquidity, for both bank types. These results seem robust for the pre- and, especially, the post- 2007-2008 financial crisis periods.

Has Persistence Persisted in Private Equity? Evidence from Buyout and Venture Capital Funds
Harris, Robert S.,Jenkinson, Tim,Kaplan, Steven N.,Stucke, Ruediger
We present new evidence on the persistence of U.S. private equity (buyout and venture capital) funds using cash-flow data sourced from Burgiss’s large sample of institutional investors. Previous research, studying largely pre-2000 data, finds strong persistence for both buyout and venture capital (VC) firms. Using ex post or most recent fund performance (as of June2019), we confirm the previous findings on persistence overall as well as for pre-2001 and post-2000 funds. However, when we look at the information an investor would actually have â€" previous fund performance at the time of fundraising rather than final performance â€" we find little or no evidence of persistence for buyouts, both overall and post-2000. For post-2000 buyouts, the conventional wisdom to invest in previously top quartile funds does not hold. Using previous fund PME at fundraising, we find modest persistence, but it is driven by bottom, not top quartile performance. On the other hand, persistence for VC funds persists even when using information available at the time of fundraising. Therefore, the conventional wisdom of investors holds for VC.

Impacts of Sector and Company Size on Effective Factor Investing:Evidence from U.S. Equity Markets
Sarkar, Salil K.,Du, Yibing,Vafai, Nima
Identifying the stable long term relationship between factors and asset returns is the main challenge of factor investing. By adopting a two-step regression methodology and controlling the impact of the business cycle, this study investigates industry sector, company size and their interactions with common factors in U.S. equity market from January 1990 to December 2016. The two-step regression recorded a significant sector effect and the influence of company size on common equity market factors. When industry sectors are included in the second-step regression, influences of three common factors: market beta, company size, and value factor are largely explained by the risk-free rate, yield curve, and industry sectors. In the large-cap portfolio, the momentum effect on long term equity returns is robust, but the size and value effects disappear. In the small-cap portfolio the momentum, however, is not significant, but the size premium is recorded in long term returns. This study documents that small-cap portfolio’s long term return is mainly determined by changes of the yield curve, credit curve, and industry sectors. These findings are robust when a business cycle dummy variable is introduced to the two-step regression. This study extended factor investing research further by examining influences of sectors and the company size on stock returns in long run: 1) market beta is mostly explained by the change of risk free rate, yield curve, and industry sectors; 2) the momentum is a determinant factor in large-cap portfolio, but not small-cap portfolio; 3) The return of small-cap portfolio is predominantly attributed to sector exposures, changes of the credit curve and yield curve. We conclude that for effective factor investing in large-cap portfolio, right sector rotation and market momentum strategies must be implemented, while in small-cap portfolio changes of yield curve and credit curve are determining factors.

Is It Time to Eliminate Federal Corporate Income Taxes?
Lane, Edward,Wray, L. Randall
As the nation is experiencing the need for ever-increasing government expenditures to address COVID-19 disruptions, rebuild the nation’s infrastructure, and many other worthy causes, conventional thinking calls for restoring at least a portion corporate taxes eliminated by the 2017 Tax Cuts and Jobs Act, especially from progressive circles. In this working paper, Edward Lane and L. Randall Wray examine who really pays the corporate income tax and argue that it does not serve the purposes most people believe.The authors provide an overview of the true purposes and incidence of corporate taxation and argue that it is inefficient and largely borne by consumers and employees, not shareholders. While the authors would prefer the elimination of the corporate profits tax, they understand the conventional thinking that taxes are necessary to help finance government expendituresâ€"even if they disagree. Accordingly, the authors present alternatives to the corporate tax that shift the burden from consumers and employees to those who benefit the most from corporate success.

Islamic Banking and Finance in Sub-Saharan Africa: Recent Developments and Existing Challenges
Ali, Abdu Seid
Although Islamic banking has been developed in Gulf and South East Asian countries, Africa, with an estimated 50 percent Muslim population, is trying to adapt itself with this industry until recently. As of end-2012, about 38 Islamic finance institutions-comprising commercial banks, investment banks, and takaful (insurance) operators-were operating in Africa. South Africa, Nigeria, Kenya and Mauritius are advancing in Islamic banking in Sub Saharan African. Growing middle class combined with its young population, the development of infrastructures and necessary changes to the regulatory and policy framework among others are the good news. However, liquidity problems, slow development of new products, regulatory issues, competition from bigger conventional banks and so on remain the challenges. However, the industry is improving and the future seems bright nowadays since many countries are adopting structural and regulatory changes. With respect to sukuk, several countries are joining the market to attract their local Muslim and Gulf and Southeast Asian investors who are interested in Shariah-compliant instruments that greatly contributes for financing huge projects and infrastructural developments. Lack of skilled manpower and public awareness together with economic, financial, legal and regulatory challenges remain prevalent.

Islamic Micro Finance Services in Ethiopia: Performances and Implications for Financial Inclusion and Poverty Alleviation
Ali, Abdu Seid
Deprivations are a worldwide incident affecting people both in developed and developing countries. The study examines the performances Islamic micro finance institutions and their implication for financial inclusion and poverty alleviation in Ethiopia. Descriptive method of research is used to understand the general overview and performance of both conventional and Islamic micro finance institutions and observe the role of Islamic micro finance institutions towards ensuring financial inclusion and reducing poverty in the country. A survey was conducted on interest free micro finance windows in the existing conventional micro finance institutions in different parts of the country. The results revealed that most of the institutions provide murabaha which is a popular form of financing small entrepreneurs and businesspersons. However, the main challenges of interest free micro finance system are unavailability of clear and detailed legislation from the regulator National Bank of Ethiopia (NBE), shortage of trained and knowledgeable workforce related to interest free micro finance services, immense and arduous administrative cost of the system and clients’ nonconformity with some Sharia principles like failure to deliver the item to the institution after they acquired it from the market on behalf the micro finance institutions.

Machine Predictions and Human Decisions with Variation in Payoffs and Skill
Michael Allan Ribers,Hannes Ullrich

Human decision-making differs due to variation in both incentives and available information. This constitutes a substantial challenge for the evaluation of whether and how machine learning predictions can improve decision outcomes. We propose a framework that incorporates machine learning on large-scale data into a choice model featuring heterogeneity in decision maker payoff functions and predictive skill. We apply this framework to the major health policy problem of improving the efficiency in antibiotic prescribing in primary care, one of the leading causes of antibiotic resistance. Our analysis reveals large variation in physicians' skill to diagnose bacterial infections and in how physicians trade off the externality inherent in antibiotic use against its curative benefit. Counterfactual policy simulations show that the combination of machine learning predictions with physician diagnostic skill results in a 25.4 percent reduction in prescribing and achieves the largest welfare gains compared to alternative policies for both estimated physician as well as conservative social planner preference weights on the antibiotic resistance externality.

Make Hay While the Sun Shines: An Empirical Study of Maximum Price, Regret and Trading Decisions
Brettschneider, Julia,Burro, Giovanni,Henderson, Vicky
Using a dynamic extension of Regret Theory, we test how the regret induced by not selling a stock when the maximum price in an investment episode is attained shapes the propensity to sell a stock. We use a large discount brokerage dataset containing US households’ trading records between 1991 and 1996. Expected utility predicts that investors should stop at a threshold, whilst a Regret agent does not necessarily stop there. We observe that investors do not follow a threshold strategy in our data. Only 31.6% of the gains are sold on the day when the maximum is attained and 25.8% of the losses are sold on the day when the minimum is attained. We find that more sophisticated and younger investors are more likely to follow a threshold strategy. Second, we find that investors are more likely to sell a stock for a gain in a moment closer in time to the maximum occurrence and at a price further from the running maximum price of the stock in the investment episode. Anticipated regret and belief updating might explain this pattern. The propensity to sell a gain steadily declines a short time after the maximum was attained. We suggest that traders might regret not selling at a time close to the maximum day and hold onto the stock if a long time has passed.

Managerial Entrenchment and Payout Policy: A Catering Effect
Gyimah, Daniel,Gyapong, Ernest
Agency theory suggests that entrenched managers are less likely to pay dividends. However, according to the catering theory, external pressures from investors can force managers to increase dividend payments. Hence, we test whether entrenched managers respond to investor demand for dividends and share repurchases. Using a large sample of 9,677 US firms over the period 1990-2016 (i.e. a total of 80,478 firm-year observations), we test and find evidence that managerial entrenchment negatively impacts dividend payments. Our findings suggest that catering effects weaken the negative impact of managerial entrenchment on payout policy and that in firms with entrenched managers an increase in the propensity to pay dividends is conspicuous only when there is external investor demand for dividends. Our results indicate that while insiders and institutional owners might not necessarily favour dividend payments, firms respond to catering incentives when dominated by insiders but not institutional owners. Overall, our findings are consistent with the view that dividend payments are a result of external pressures to reduce agency problems associated with firms run by entrenched managers.

Monetary Policy and Bank Concentration
Chu, Yongqiang,Zhang, Tim
This paper examines how monetary policy affects bank concentration. We show that when the policy rate rises, banks operating in more competitive markets are more likely to be acquired or fail outright. We find that the effect is more pronounced among smaller banks, causing the banking sector to be more dominated by a smaller number of large banks over time. Consistent with the market power channel, we show that the effect is driven by banks' inability to pass on rate hikes to the asset side and being forced to pass on rate hikes to the liability side in competitive markets. For banks with the lowest 25% market power, when the Fed funds rate rises by 100 bps, their net interest margin declines by 60% of its mean more than other banks. We also show that bank or branch exits lead to a significant decline in credit supply to small businesses and information-intensive loans of local borrowers.

Nifty 50 Option Time Spreads
Slivka, Ronald T.
The objective of this study was to identify and test preliminary rules for trading call option time spreads and then to assess opportunities for further research to improve on those rules. To do so the theoretical and empirical properties of near-the-money time spreads were used to develop four rules for profitably trading in India’s Nifty 50 (NSE 50) call options. Day-end pricing for 2015 â€" 2019 included periods of rising, falling and stable volatility. The resulting four rule algorithm produces positive results on out-of-sample data and was found to outperform a buy and hold strategy. Because the general procedure followed for rule development was not country specific, it was separately applied to options on China’s SSE 50 index where the algorithm was also found to outperform a hold-to-expiry strategy in every year tested. These related studies of NSE 50 and SSE 50 option time spreads provide a helpful addition to the growing knowledge about the developing derivatives markets in India and China. New directions for further research are described.

Off Target: On the Underperformance of Target-Date Funds
Brown, David C.,Davies, Shaun
Target-date funds (TDFs) are popular vehicles that provide investors with an evolving asset allocation to meet their needs at some future date (e.g., retirement). While TDFs provide investors with extensive diversification and active rebalancing, TDFs are also a type of fund-of-funds. As such, investors pay multiple layers of fees as most TDFs charge fund-of-funds' fees and also hold funds that collect additional fees. We show that TDFs are easy to emulate with a portfolio of cost-efficient exchange-traded funds (ETFs) and we coin these portfolios Replicating Funds (RFs). RFs substantially outperform TDFs, exhibit low tracking error, do not suffer from cash drag, and require infrequent rebalancing. Our analysis shows that TDF sponsors collectively charged nearly $2.5 billion in excess fees in 2017 alone. We provide a normative rule-of-thumb for investors to construct their own RFs using low-cost ETFs.

Optimal Investment Strategies for Pension Funds with Regulation-Conform Dynamic Pension Payment Management in the Absence of Guarantees
Lichtenstern, Andreas,Zagst, Rudi
In this article we consider the post-retirement phase optimization problem for a specific pension product in Germany that comes without guarantees. The continuous-time optimization problem is defined consisting of two specialties: first, we have a product-specific pension adjustment mechanism based on a certain capital coverage ratio which stipulates compulsory pension adjustments if the pension fund is underfunded or significantly overfunded, and second, due to the retiree's fear of and aversion against pension reductions, we introduce a total wealth distribution to an investment portfolio and a buffer portfolio to lower the probability of future potential pension shortenings. Due to the inherent complexity of the continuous-time framework, the discrete-time version of the optimization problem is considered and solved via the Bellman principle. In addition, for computational reasons, a policy function iteration algorithm is introduced to find a stationary solution to the problem in a computationally efficient and elegant fashion. A numerical case study on optimization and simulation completes the work with highlighting the benefits of the proposed model.

Present Bias, Asset Allocation and the Yield Curve
Goossens, Jorgo T.G.,Werker, Bas J. M.
This paper presents a present-biased general equilibrium model that explains many features of bond behavior. Present-biased investors increase (decrease) short-term (long-term) hedge demands compared to standard preferences. Hence, present bias drives up (down) short-term bond prices (yields) and drives down (up) long-term bond prices (yields), explaining the bond premium puzzle. The model produces realistic bond behavior with a present-bias factor of beta=0.35 and a long-term annual discount factor of delta=0.97, in line with the experimental literature. Bond behavior is best explained for a present-bias interval of at most 1 year, providing an estimate for the investor's duration of the present.

Pricing Equity-Bond Covariance Risk: Between Flight-to-Quality and Fear-of-Missing-Out
Perras, Patrizia,Wagner, Niklas
Motivated by Merton (1973), we propose a novel bivariate intertemporal asset pricing model, which relates expected equity and bond market returns to their conditional covariance. Investors' dynamic hedging demand coincides with covariance risk, which in turn plays a central role in explaining contemporaneous time-variation in expected market returns. Our model predictions are consistent with variations in expected equity and bond returns that include flight-to-quality and fear-of-missing-out episodes, both of which coincide with low levels of equity-bond covariance. We identify determinants of time-variation in conditional covariance and thus potential drivers of flight-to-quality and fear-of-missing-out. Unanticipated changes in expected inflation, market illiquidity and stock market uncertainty predict changes in the equity-bond covariance, where the contribution of each variable is state-dependent. In particular, the non-linear effects of shocks to inflation act as a key driver.

Real-Time Detection of Volatility in Liquidity Provision
Matthew Brigida

Previous research has found that high-frequency traders will vary the bid or offer price rapidly over periods of milliseconds. This is a benefit to fast traders who can time their trades with microsecond precision, however it is a cost to the average market participant due to increased trade execution price uncertainty. In this analysis we attempt to construct real-time methods for determining whether the liquidity of a security is being altered rapidly. We find a four-state Markov switching model identifies a state where liquidity is being rapidly varied about a mean value. This state can be used to generate a signal to delay market participant orders until the price volatility subsides. Over our sample, the signal would delay orders, in aggregate, over 0 to 10% of the trading day. Each individual delay would only last tens of milliseconds, and so would not be noticeable by the average market participant.

Resisting the Return to Managerialism: Institutionalizing the Shareholder Voice in the Monitoring Model
Cox, James D.,Thomas, Randall S.
There are many lessons to be drawn from the sweep of history. In law, the compelling story repeatedly told is the observable co-movement of law on the one hand and economic, social and political changes on the other hand. Aberrations, however, do arise, but generally do not persist in the long term. Contemporary corporate law seems to be on the cusp of such an abnormality as legal developments and proposed reforms for corporate law are currently conflicting with the direction in which the host environment is moving. This article identifies a series of contemporary judicial and regulatory corporate governance developments that are at odds with multiple forces unleashed by today’s ownership of public companies being highly concentrated in the hands of various types of financial institutions. Our purpose is not to focus on these developments as such but to address a much larger question that lies behind them: should courts and regulators have interceded to retard the forces created by such concentration of ownership of public companies? To address this question, we travel back in time to post WWII America and the widely practiced model of managerialism when shareholders were analogous to children, seen but not heard. That model was replaced by today’s monitoring model which empowers oversight of management in the hands of outside directors whose obeisance, at least on paper, is anchored in the firm’s residual claimants, the stockholders who elect the directors. But as we discuss, the monitoring board has something of a checkered history in serving this function. We argue that from its inception, the monitoring board was incomplete because it was formed in an era where the received model was dispersed, not concentrated, ownership. We next challenge the emerging New Paradigm that is being advanced as the future model for corporate governance. We conclude the article with a set of recommendations we believe will bolster the heretofore incomplete monitoring model for corporate governance.

Sell or Hold? On the Value of Non Performing Loans and Mandatory Write-Off Rules
Pauer, Florian,Pichler, Stefan
This paper investigates the decision rational banks face when considering selling a non performing loan (NPL). We start with developing a risk neutral pricing model for non performing loans and show that even if a bank and a potential buyer agree on the expected recovery value a difference in the precision in the estimation of the drift of the underlying recovery process may greatly influence the decision to sell a NPL. This difference could be due to private information of the bank about the borrower’s loan history or due to a larger sample of similar borrowers where defaults can be observed. Furthermore, the question if it is optimal to hold on to a NPL is also affected by capital requirements and funding costs banks typically face. This question is of particular interest in the light of mandatory write-off policies, which basically force banks to write-off/provision for NPLs after some time has passed. This raises the question whether or not banks are incentivized to sell NPLs at prices that are too low and thus represent a wealth transfer from banks to other capital market participants. Given the results presented here it can be concluded that these rules would indeed lead to the aforementioned transfer and these policies should be refined to incorporate a bank' ability to estimate time-series properties of a NPL's underlying recovery rate process.

Shareholding Structure and Value Creation in Central Eastern Europe
Harbula, Péter,Kerekes, Adam
This article aims to analyze the interaction between shareholding structure and value creation in the transition economies of Central Eastern Europe. Our study set out to verify several assumptions on the relationship between ownership and performance in Central Eastern Europe.Using a data sample of listed companies over a period of 20 years, we analyze the value creation as measured by the share price versus a cross section analysis of return against multiple factors, including but not limited to shareholding structures. We use exclusively listed in the regional stock exchanges and analyze this with the specific ownership structure that resulted in such transition economies. We have found that a major, private shareholder led companies and diffused ownership companies significantly outperform the sample average whether in terms of total shareholder returns or other metrics. We have also observed that state led companies underperform peers with another shareholding structure or the sample average. More generically, whenever the State plays a significant role in the shareholding structure (which we consider a proxy for a direct or indirect management role or influence), the performance seems to be below that sample average.

Solving path dependent PDEs with LSTM networks and path signatures
Marc Sabate-Vidales,David Šiška,Lukasz Szpruch

Using a combination of recurrent neural networks and signature methods from the rough paths theory we design efficient algorithms for solving parametric families of path dependent partial differential equations (PPDEs) that arise in pricing and hedging of path-dependent derivatives or from use of non-Markovian model, such as rough volatility models in Jacquier and Oumgari, 2019. The solutions of PPDEs are functions of time, a continuous path (the asset price history) and model parameters. As the domain of the solution is infinite dimensional many recently developed deep learning techniques for solving PDEs do not apply. Similarly as in Vidales et al. 2018, we identify the objective function used to learn the PPDE by using martingale representation theorem. As a result we can de-bias and provide confidence intervals for then neural network-based algorithm. We validate our algorithm using classical models for pricing lookback and auto-callable options and report errors for approximating both prices and hedging strategies.

The Epps effect under alternative sampling schemes
Patrick Chang,Etienne Pienaar,Tim Gebbie

Time and the choice of measurement time scales is fundamental to how we choose to represent information and data in finance. This choice implies both the units and the aggregation scales for the resulting statistical measurables used to describe a financial system. It also defines how we measure the relationship between different traded instruments. As we move from high-frequency time scales, when individual trade and quote events occur, to the mesoscales when correlations emerge in ways that can conform to various latent models; it remains unclear what choice of time and sampling rates are appropriate to faithfully capture system dynamics and asset correlations for decision making. The Epps effect is the key phenomenology that couples the emergence of correlations to the choice of sampling time scales. Here we consider and compare the Epps effect under different sampling schemes in order to contrast three choices of time: calendar time, volume time and trade time. Using a toy model based on a Hawkes process, we are able to achieve simulation results that conform well with empirical dynamics. Concretely, we find that the Epps effect is present under all three definitions of time and that correlations emerge faster under trade time compared to calendar time, whereas correlations emerge linearly under volume time.

The Impact of Research Funding on Knowledge Creation and Dissemination: A study of SNSF Research Grants
Rachel Heyard,Hanna Hottenrott

This study investigates the impact of competitive project-funding on researchers' publication outputs. Using detailed information on applicants at the Swiss National Science Foundation (SNSF) and their proposals' evaluation, we employ a case-control design that accounts for individual heterogeneity of researchers and selection into treatment (e.g. funding). We estimate the impact of grant award on a set of output indicators measuring the creation of new research results (the number of peer-reviewed articles), its relevance (number of citations and relative citation ratios), as well as its accessibility and dissemination as measured by the publication of preprints and by altmetrics. The results show that the funding program facilitates the publication and dissemination of additional research amounting to about one additional article in each of the three years following the grant. The higher citation metrics and altmetrics of publications by funded researchers suggest that impact goes beyond quantity, but that funding fosters quality and impact.

The Impacts of Emotions and Personality on Investors’ Abilities to Manage Their Debts
Rendall, Stella,Brooks, Chris,Hillenbrand, Carola
This paper examines the impacts of retail borrowers’ emotions and personality traits on their abilities to engage in appropriate responses when things unexpectedly go wrong and they get into debt repayment difficulties. We establish several scenarios where borrowers are hit with unforeseen circumstances that affect their abilities to make their loan payments and we classify and evaluate the riskiness of the strategies they state that they would adopt in those situations. Via an extensive on-line survey conducted in the UK, we show that borrowers who were most comfortable about taking on debts in the first place, those who show neurotic tendencies, and those who believe that they have control over events rather than being controlled by them, are more likely to undertake high risk strategies when faced with unforeseen issues that affect their ability to meet their debt interest and repayment costs. We also find that respondents who identify as feeling excited, alert or guilty, as well as younger borrowers and those who are single or renters, are more likely to opt for risky approaches. Our findings have potentially important implications for lenders, regulators and debt counselling services regarding the types of people who are most likely to get into debt troubles.

The Relationship between Financial Literacy and Financial Inclusion
Grohmann, Antonia,Menkhoff, Lukas
About two billion people in the world do not own a financial account and there are many more who use financial services only occasionally. In the past, initiatives which address these problems of financial exclusion focused on the supply side of financial markets, in particular by increasing the branch network of banks and by offering cheap bank products. While this had the desired effect, recent evidence shows that improving the demand side of financial markets is also helpful. There are numerous initiatives and public policies to enhance financial education and to improve financial literacy. Microeconometric studies, often randomized controlled trials, show that financial literacy has a causal effect on financial inclusion; educated individuals understand the advantages of financial services better but also feel more confident about contacting providers. Cross-country evidence indicates that in poorer countries improved financial supply and demand are substitutes, i.e., they work independently of each other. In higher-income economies, however, these instruments are complements, i.e., it is useful to improve financial literacy in order to make better use of available financial services.

The power of islamic scholars lecture to decide using Islamic bank with customer response strength approach
Suryo Budi Santoso,Herni Justiana Astuti

The purpose of this study is to analyze the power of Islamic scholars lectures to decide using Islamic banks with a customer response strength approach. The sampling technique uses purposive sampling, and the respondents were those who attended lectures on Islamic banks delivered by Islamic scholars. The number of respondents who met the requirements was 96 respondents. Data were analyzed using the customer response strength method. The instrument has met the valid and reliable criteria. The results showed 99% of the total number of respondents acted according to their perceptions of the contents of Islamic banks lectures. Lecture material delivered by scholars about Islamic banks has a strong relationship with their responses ranging from giving attention, interest, fostering desires, and beliefs to having an interest in making transactions with Islamic banks.

The short-run impact of COVID-19 on the activity in the insurance industry in the Republic of North Macedonia
Viktor Stojkoski,Petar Jolakoski,Igor Ivanovski

This paper investigates the impact of the COVID-19 pandemic on the insurance industry in the Republic of North Macedonia during the first half of 2020. By utilizing seasonal autoregressive models and data for 11 insurance classes, we find that the insurance activity shrank by more than 10% compared to what was expected. The total loss in the industry was, however, much less than the amount of funds made available by the Insurance Supervision Agency. This was because the pandemic induced changes in the activity structure - the share of Motor vehicles class fell at the expense of the property classes.

Why are Residential Property Tax Rates Regressive?
Amornsiripanitch, Natee
Among single family homes that enjoy the same set of property tax-funded amenities and pay the same statutory property tax rate, owners of cheap houses pay 50% higher effective tax rates than owners of expensive houses. This pattern appears throughout the United States and is caused by systematic assessment regressivity -- cheap houses are overappraised relative to expensive houses. At least 30% of the observed regressivity can be explained by tax assessors' flawed valuation methods, which ignore variation in priced house and neighborhood characteristics. Infrequent reappraisal explains less than 10% of the phenomenon. Heterogeneous appeal behavior and outcomes do not contribute. Overtaxation of minorities and low-income households is a by-product of assessment regressivity because these households sort into cheap houses. Within the same local house price decile, black households are proportionately taxed, while Hispanic and low-income households are undertaxed. Taken at face value, correcting assessment regressivity would increase poor homeowners' net worth by more than 15%.