Research articles for the 2021-01-15

APV-Verfahren und Fremdkapital Beta (APV-Approach and Debt Beta)
Enzinger, Alexander
German Abstract: Auch wenn dem Debt Beta Konzept in Theorie und Bewertungspraxis mittlerweile viel Raum eingeräumt wird, bleiben die Interdependenzen mit dem APV-Ansatz oft unbeachtet. Der vorliegende Beitrag versucht diese Lücke zu schließen. Aufbauend auf den Grundlagen zur Ermittlung des Debt Beta wird zum einen gezeigt, welche impliziten Annahmen zum Debt Beta das APV-Verfahren in der Regel unterstellt, die zur Herstellung der Konsistenz bei Anwendung anderer DCF-Verfahren zu berücksichtigen sind. Zum anderen wird dargestellt, wie die bei Anwendung anderer DCF-Verfahren getroffenen Annahmen zum Debt Beta den nach dem APV-Verfahren ermittelten Unternehmenswert beeinflussen.English Abstract: Even though the debt beta concept is meanwhile comprehensively covered in theory and practical valuation, the interdependence with the APV-approach is barely considered. This paper aims to close this gap. Based on the principles of debt beta calculation first the implicit assumptions regarding the debt beta that are regularly supposed by applying the APV-approach, relevant for achieving consistent valuation results with other DCF methods, are examined. Second it is analyzed, how assumptions regarding debt beta when applying other DCF-methods influence the company value calculated by the APV-approach.

Bidual Approaches in Risk Representation
Balbás, Alejandro,Balbs, Beatriz,Balbs, Raquel
Downside and deviation risk measures are becoming more and more important in many disciplines with clear interfaces with Applied Mathematics and Operations Research. Their dual representations have played critical roles in most of their applications (risk management, portfolio selection, pricing and hedging, etc.), but, to the best of our knowledge, bidual representations were never profoundly studied. New linear bidual representations will be provided, and their great capacity to linearize many problems will be proved, with special focus on risk optimization. This is important because there are very tractable necessary and sufficient optimality conditions and resolution algorithms in Linear Programming. Moreover, in the linearization process, one will have to introduce new decision variables providing us with very important information, such as sensitivities with respect to the selected risk measure and sensitivities with respect to the selected model (model risk). The theory will be presented for general Banach spaces, and an illustrative example will be given.

Black Swan Event: An Evidence from China’s Economics Efects
Stavrova, Elena Velkova,Paskaleva, Mariya,Stoykova, Ani
The prognosis of upcoming crises and the course of actually understanding them is increasingly becoming a major subject of discussions in pursuit of reliable indicators. The trade war between the United States and China, along with the COVID-19 pandemic are two events that took place in the Chinese economy with the aforementioned characteristics of the Black swan phenomenon, to which this latest professional analysis is devoted. The objective of this research is to examine the response of the Shanghai Stock Exchange Composite (SSEC) index, in addition to its relation with macroeconomic variables contributing towards a possible Black Swan Event. We employ an econometric methodology comprising of a unit root test, descriptive statistics, linear regression and correlation analysis for the period 2007-2019. Our results illustarte that the bubble from 2015, which is classified as a Black Swan event by many researchers, has a negative influence on the SSEC index. We can further deduce that there were some psychological effects on the Chinese stock market that lead to both, positive and negative trends of SSEC indices. The main findings confirmed that the Consumer Price Index, Exchange Rate, Interest Rate, Unemployment, GDP and Trade Balance were significantly elaborative macroeconomic variables, that had a substantial impact on the SSEC index.

Contracts as Regulation: The ISDA Master Agreement
Borowicz, M. Konrad
This article proposes a rule of contractual interpretation for regulatory contracts defined as contracts 1) used by a large number of market participants, 2) subject to limitations on deviation, and 3) designed with market problems (such as negative externalities) in addition to transactional problems (such as transaction costs) in mind. The rule states that the outcome of the interpretation of regulatory contracts must not be inconsistent with the objectives of the regulatory framework applicable to the market in which the contract is used. The article suggests that the reliance on that rule is normatively justified in cases where the regulatory objectives are clearly defined and particularly when the alternative outcome is to void the contract or its provision. By adopting the regulatory rule for contract interpretation, courts can preserve the autonomy of private regulatory regimes created through contracts without sacrificing public policy objectives. Several examples of the application of the rule to the interpretation of selected provisions of the ISDA Master Agreement and the ISDA Credit Definitions are discussed.

Debt Financing and Risk Management
Babenko, Ilona,Bessembinder, Hendrik,Tserlukevich, Yuri
We obtain detailed data on bank lending agreements and derivative positions of U.S. oil and gas producers during the 1999-2019 period to study interactions between financing and hedging decisions. Using the emergence of fracking technology as an exogenous shock to firms' financing needs, we document sharp increases in debt financing accompanied by increased hedge ratios and longer hedge maturities. We document that bank lending contracts often include covenants that require hedging, with the majority specifying an explicit minimum. Our results support the interpretation that these hedge covenants are binding, and are structured to mitigate potential agency conflicts originating from the priority of derivatives in default and incentives for firms to speculate with derivatives. We also show that firms with bank-imposed hedging requirements perform better during the COVID-19 pandemic. Our results support the interpretation that firms' hedging decisions should be viewed as outcomes from constrained optimization shaped in part by prior financing choices.

Deposit Insurance, Bank Ownership and Depositor Behavior
Atmaca, Sumeyra,Kirschenmann, Karolin,Ongena, Steven,Schoors, Koen
We employ proprietary data from a large bank to analyze how â€" in times of crisis â€" depositors react to a bank nationalization, re-privatization and an accompanying increase in deposit insurance. Nationalization slows depositors fleeing the bank, provided they have sufficient trust in the national government, while the increase in deposit insurance spurs depositors below the new 100K limit to deposit more. Prior to nationalization, depositors bunch just below the then-prevailing 20K limit. But they abandon bunching entirely during state-ownership, to return to bunching below the new 100K limit after re-privatization. Especially depositors with low switching costs are moving money around.

Extreme Valuations and Future Returns of the S&P 500
Rowles, Shaun,Mitchell, Andrew
Higher than average Price-to-Earnings (P/E) ratios and Cyclically-Adjusted Price-to-Earnings (CAPE) ratios have been tolerated by investors recently on the basis of low interest and inflation rates. This white paper analyzes what level of returns can reasonably be expected going forward from today’s elevated valuation multiples.

Global Report on Business Continuity Planning and Management (BCP/BCM). Survey results
Bongini, Paola,Iwanicz-Drozdowska, Malgorzata,Roggi, Oliviero,Elliot, Viktor
In the last twenty years, ERM has gained relevance in business management and was put to test in many “tail” situations, starting from the SARS outbreaks in 2003 up to recent financial crises (subprime and sovereign debt crises) and regional pandemic. Notwithstanding the lesson learnt, prima facie this new, global pandemic seems to have caught us off guard. Against this background, our main research question is whether business continuity planning and management has reached a maturity so as to make a difference in extreme environments as the one we are experiencing nowadays, helping organizations to weather this perfect storm.To answer this question, we launched a global survey through digital channels during a period of major lockdown for many countries (April â€" May 2020). This report analyzes the results of the global survey from two main points of view. We present responses from a global perspective, by taking the entire sample into account and separately high-income (HI) and middle-income (MI) countries.

How Do Options Add Value? Evidence from the Convertible Bond Market
Lee, Inmoo ,Renjie, Rex Wang,Verwijmeren, Patrick
This paper provides evidence that the availability of individual stock options adds value to security issuers. We focus on convertible bond issues because pricing convertible bonds requires essentially the same set of information necessary to price options. By exploiting the SEC’s minimum stock price requirement for option listing to employ a regression discontinuity design, we find that the availability of stock options significantly affects the pricing of convertible bonds. In line with options providing information, the effect is stronger when the overall information environment is poor. Listed options help issuers attract more convertible bond buyers and reduce the cost of financing. Overall, our results highlight the value relevance of the options market.

Institutional Corporate Bond Demand
Bretscher, Lorenzo,Schmid, Lukas,Sen, Ishita,Sharma, Varun
We compile a rich dataset that links institutional investors' position level holdings with corporate bond characteristics and estimate demand elasticities with respect to critical sources of risk. Persistence in institutions' holdings provide us with an instrument to isolate exogenous movements in prices. We find significant heterogeneity in demand elasticities across the main players in the corporate bond market, namely insurers, pension funds, and mutual funds. Long-term investors are sensitive to interest rate movements and supply liquidity, whereas mutual funds, with shorter investment horizon and benchmark constraints, demand liquidity. Price impact increased post-crisis for all institutions and has remained higher than the pre-crisis levels, signaling a general decline in bond market liquidity due perhaps to regulatory changes in the corporate bond market. Price impact jumped up significantly during COVID-19, perhaps suggesting a reluctance of dealers to intermediate in the market place, and illustrating that firms' funding opportunities are highly sensitive to investors' latent demand shocks. Our results have wide ranging implications for corporate bond pricing due to heterogeneity in investors and investment mandates, and are hard to reconcile with standard, representative agent based models.

Is the Bottom Line the Top Priority? A Choice Model of Revenue and Earnings Guidance
Boone, Audra L.,Lewis, Craig M.,Starkweather, Austin,White, Joshua T.
Based on the observation that managers provide almost 30% more revenue than earnings forecasts in recent periods, we jointly explore the decision to provide or forego revenue and/or earnings guidance. Our modeling innovation combines a random effects multinomial logit model, instrumental variables, and a correction for selection bias, which correctly classifies over 90% of observed guidance decisions. We find a stronger investor reaction to guidance surprises for firms whose guidance choice conforms to the predicted decision, suggesting that predictable guidance policies engender forecast credibility. The market response is driven more by managerial guidance than analyst revisions. Non-guiders quickly switch to guiding when the choice model suggests that guidance is the expected choice.

Limited Liability, Strategic Default and Bargaining Power
Balatti, Mirco,Lopez-Quiles, Carolina
In this paper we examine the effects of limited liability on mortgage dynamics. While the literature has focused on default rates, renegotiation, or loan rates individually, we study them together as equilibrium outcomes of the strategic interaction between lenders and borrowers. We present a simple model of default and renegotiation where the degree of limited liability plays a key role in agents' strategies. We then use Fannie Mae loan performance data to test the predictions of the model. We focus on Metropolitan Statistical Areas that are crossed by a State border in order exploit the discontinuity in regulation around the borders of States. As predicted by the model, we find that limited liability results in higher default rates and renegotiation rates. Regarding loan pricing, while the model predicts higher interest rates for limited liability loans, we find no such evidence in the Fannie Mae data. We further investigate this by using loan application data, which contains the interest rates on loans sold to private vs public investors. We find that private investors do price in the difference in ex-ante predictable default risk for limited liability loans.

Monetary Policy Transmission in Segmented Markets
Eisenschmidt, Jens,Ma, Yiming,Zhang, Anthony Lee
This paper studies two frictions that impede the effective pass-through of monetary policy in the European repo market. Collateral scarcity creates a wedge between the ECB's Deposit Facility Rate and inter-dealer repo rates. Dealer market power causes inter-dealer repo rates to pass through imperfectly to customer-facing OTC repo rates. Using a dataset covering both inter-dealer and OTC repo trades, we provide empirical evidence consistent with dealer market power in the OTC repo market. We build a model to illustrate how collateral scarcity and market power create interacting frictions in repo markets, and we verify its predictions using the September 2019 monetary policy rate cut. The model implies that policies that alleviate dealer market power, such as customer access to centralized trading and customer-facing secured funding facilities like the Federal Reserve's RRP, can alleviate dealer market power and improve the pass-through of monetary policy.

Mutual Fund Dual Holdings and Shareholder-Creditor Conflicts
Renjie, Rex Wang,Xia, Shuo
We study the impacts of mutual fund families on corporate governance when they simultaneously hold bonds and stocks from the same firm. We present evidence that such dual holdings prevent debt overhang problems, allowing firms to increase valuable investments and refinance by issuing bonds with lower yields and fewer restrictive covenants. The effect is stronger for firms that would otherwise face financial constraints. We mitigate potential endogeneity concerns by exploiting plausibly exogenous variations in dual ownership from cross-family fund mergers. Overall, our results suggest that fund families internalize the shareholder-creditor agency conflicts of their portfolio companies, highlighting the benefits of such institutional ownership.

Network Complexity and Financial Behavior - Volume-Price Distribution in Financial Market
Shi, Leilei,Wang, Bing-Hong
Current study has revealed that it is time to move beyond behavioral finance to social finance in network complexity, which studies the structure of social interactions. Some pioneering scholars in economics and finance have provided a considerable number of empirical evidences of how financial ideas transmit, spread and evolve, and how social processes affect financial outcomes. However, there is big challenge to have a widely acceptable theory in the social finance. After a brief perspective on the historical development from network theories to complex networks, here we focus on the application in finance. We propose a unified theory and two sets of explicit volume distribution models over a price range from Shi’s wave equation in a new mathematical method. The theory is also evidenced validity by the empirical evidence on nonlinear V-shaped price pressures utility. It predicts the policies effective about quarantine and mask wearing against COVID-19 pandemics.

Non-US Global Banks and Dollar (Co-)Dependence: How Housing Markets Became Internationally Synchronized
Ehlers, Torsten,Hoffmann, Mathias,Raabe, Alexander
US net capital inflows drive the international synchronization of house price growth. An increase (decrease) in US net capital inflows improves (tightens) US dollar funding conditions for non-US global banks, leading them to increase (decrease) foreign lending to third-party borrowing countries. This induces a synchronization of lending across borrowing countries, which translates into an international synchronization of mortgage credit growth and, ultimately, house price growth. Importantly, this synchronization is driven by non-US global banks’ common but heterogenous exposure to US dollar funding conditions, not by the common exposure of borrowing countries to non-US global banks. Our results identify a novel channel of international transmission of US dollar funding conditions: As these conditions vary over time, borrowing country pairs whose non-US global creditor banks are more dependent on US dollar funding exhibit higher house price synchronization.

Rise of Domestic Banks in EME Cross-border Credit Intermediation
Jiang, Bo,Xu, Douglas
While the volume of cross-border capital inflow to emerging market economies (EMEs) has been increasing since 1970s, the last three decades have witnessed a more pronounced change in the structure of these cross-border capital flows. In this paper, we document the rise of domestic global banks in EMEs and the growingly important role they have played in channeling cross-border capital since the 1990s. We further provide evidence that this structural change in the cross-border capital flow to EMEs is likely to be driven by the transformation of the U.S. money market since the end of the 1980s. Using detailed documentation on cross-border loans, we demonstrate that foreign and domestic lenders have drastically different preferences on lending bases when extending credit to corporations in EMEs: foreign lenders exhibit a much higher reluctance to lend against hard assets as collateral. On the basis of differentiated lending technologies, we show that the rise of domestic global banks in channeling cross-border capital to EMEs has had a profound impact on i) who receives the capital and ii) how the capital is received. Inspired by these micro-level findings, we conduct a cross-country analysis and find that the rise of domestic global banks in transmitting cross-border capital to EMEs can have a far-reaching impact on these economies at the aggregate level. In particular, we find that the rise of domestic global banks in EMEs can greatly i) reshape the industry structure of these economies and ii) increase the economies’ susceptibility to global financing cycles.

The Increased Toxicity of the U.S. Treasury Security Market
Hein, Scott E.
This short research paper documents the fact that exclusively watching for rising yields on conventional U.S. Treasury securities to reflect increased inflationary fears in the U.S. is no longer appropriate. With the Federal Reserve seeking to keep short-term nominal yields near zero for an extended period, conventional Treasury yields have not shown the full extent of rising fears of inflation in financial markets. In this monetary environment, the yields on Treasury Inflation Protected Securities (TIPS) have been more reflective of rising inflation fears. TIPS yields have become increasingly negative in absolute terms during the latter part of 2020. The negative yields on TIPS further suggests that all Treasury investors should be expecting lost purchasing power when they hold onto such securities.

The Measure of the Middle Class
Tanimura, Steven
The term, ‘middle class’, is constantly used to describe some average group of individuals, households or families. Various definitions and measures are used within the public policy, media and academic arenas. And, yet, there is no definitive consensus as to what middle class means or how to measure it.It seems that there are a number of nuances to the concept of the middle class that may not lend itself to direct measurement, outside of specialized surveys. The most common approach to defining and measuring the middle class is through the use of some form of income. Generally the concept of the money income seems to the broadest and most useful, through it presents certain problems upon closer examination. Other metrics used or proposed include wealth and consumption. Wealth as a metric is often of interest especially where there is concern over inequality. The consumption metric is more directly related to income, but the manner in which it is defined and collected is where it may present certain advantages over income.There are more subjective aspects of this topic which is often used to better identify those belonging to the middle class. Its qualitative nature makes it difficult to measure on some consistent basis. However, it seems that this area needs further exploration.The purpose of this paper is not to delve into the areas of poverty or inequities of the income or wealth distribution. It sole purpose is to attempt to examine the definition of middle class that may lead to a useful metric to measure it. As to the various metrics available, an examination of the standard ones will be made, as well as some non-standard ones. The paper's objective is to highlight which metrics may be most appropriate and what changes should be made to provide a more robust method of measuring the middle class.Assuming one can define, albeit imperfectly, a middle class, then it naturally follows that a lower class and upper class will also be defined.

Who Influences Whom? Behavior Contagion among Investors
Fallahgoul, Hasan,Lin, Xin
Social interaction and information transmission are essential components of pricing and trading in financial markets. To investigate the behavior contagion and information cascades among investors and sectors, we deploy a jump-diffusion process on investor sentiment -- a novel dataset from StockTwits. Calibrating the process, we find that fundamental, professional, and swing traders are the most influential investors and leading in information cascades within investment approach, experience, and holding period categories, respectively, while momentum, novice, and position traders are the least. Furthermore, the COVID-19 Pandemic period systematically has a high impact on the occurrence of dispersing.