Research articles for the 2021-01-22

A New Efficient Approximation Scheme for Solving High-Dimensional Semilinear PDEs: Control Variate Method for Deep BSDE Solver
Takahashi, Akihiko,Tsuchida, Yoshifumi,Yamada, Toshihiro
This paper introduces a new approximation scheme for solving high-dimensional semilinear partial differential equations (PDEs) and backward stochastic differential equations (BSDEs). First, we decompose a target semilinear PDE (BSDE) into two parts, namely "dominant" linear and "small" nonlinear PDEs. Then, we apply a Deep BSDE solver with a new control variate method to solve those PDEs, where approximations based on an asymptotic expansion technique are effectively applied to the linear part and also used as control variates for the nonlinear part. Moreover, our theoretical result indicates that errors of the proposed method become much smaller than those of the original Deep BSDE solver. Finally, we show numerical experiments to demonstrate the validity of our method, which is consistent with the theoretical result in this paper.

Alpha Found: The Mathematical Structure of CAPM, EMH, and the Volatility Effect
Bowling, Michael
With the volatility effect as a gateway, this paper constructs a new single-factor return model for capital asset prices. The model is built using only elementary techniques. To accomplish this, a new risk measure is introduced such that the volatility effect becomes not an economic or behavioral anomaly, but a mathematical expectation. Consequently, common performance evaluation measures come under new scrutiny. CAPM is shown to be a special case of a more general single-factor model. The ex-ante model and methods have strong explanatory value at the level of analytical expression and simulation. The ex-post estimation techniques give a range of possible ex-ante conditions that lead to market outcomes.

Assessing the Impact of COVID-19 on Major Industries in Japan: A Dynamic Conditional Correlation Approach
Kanno, Masayasu
This study assesses the impact of the novel coronavirus disease (COVID-19) cases on the Japanese stock market. As of October 30, 2020, the cumulative number of cases in Japan has reached over one hundred thousand. COVID-19 has significantly affected both the lifestyle and the economy in Japan. First, this study develops composite stock indices by industry sector and prefecture, taking into consideration the effects of the increase in infections on industries and firms in the core prefectures. Second, this study investigates the dynamic conditional correlations between the composite stock index returns and the increment in COVID-19 cases using dynamic conditional correlation multivariate GARCH models. Finally, it can contribute to financial research in terms of coexistence of regional business economies with COVID-19.

Can Informational Interventions Be Effective Policy Tools? An Initial Assessment of the Social Security Statement
Smith, Barbara A.
To inform workers about potential future Social Security benefits, the Social Security Administration employs an informational intervention: mailing Social Security Statements. In this article, the author uses linear probability models and agency administrative data to analyze a behavioral effect of Statement receipt; specifically, its effect on the age at which workers claim their retirement benefits. Results for individuals who received one Statement mailing by age 62 are compared with those for individuals who received multiple mailings, and with those who received none, during the 1975â€"2007 study period. Workers who received multiple Statements were found to be significantly more likely to claim retirement benefits at later ages than were other workers, and Statement receipt was positively associated with employment at ages 62â€"70. The author also compares the relative effects of an educational outreach (in the form of Statement mailings) and a direct policy change (involving the full retirement age) on claiming behavior and finds that the magnitudes of the two effects are similar.

Demand for Idiosyncratic Lottery-like Payoffs and the Cross-section of Expected Returns
Ince, Baris,Ozsoylev, Han N.
Motivated by existing evidence of a preference among investors for stocks with high maximum daily returns, we document that lottery-like payoffs measured by maximum daily returns are almost entirely idiosyncratic. Firm-level cross-sectional regressions and portfolio-sort analyses prove that there is a significantly negative relation between idiosyncratic maximum daily returns (IMAX) and future stock returns. While beta anomaly, negative (positive) risk-adjusted returns generated by high (low) market beta stocks, disappears when portfolios are constructed to be neutral to idiosyncratic maximum daily returns, the significantly negative return spread between the stocks with extreme idiosyncratic lottery-like payoffs are robust to various firm-specific controls and risk factors. Investor sentiment is the dominant factor to trigger the demand for stocks with high idiosyncratic lottery-like payoffs. Finally, the relationship between idiosyncratic maximum daily returns and subsequent returns is stronger among stocks with low institutional ownership, low market capitalization, low analyst coverage, low liquidity, and high idiosyncratic volatility.

Do Short-Sale Constraints Inhibit Information Acquisition? Evidence from Two Natural Experiments
Su, Lixin (Nancy),Wong, Sonia Man-Lai,Xue, Yuan,Zhao, Xiaofeng
This study examines how short-sale constraints affect investors’ information acquisition and thereby shape stock price efficiency. We exploit two quasi-natural experiments that relax short-sale constraints in the US and China, respectively. We find that the removal of short-sale constraints increases investors’ information acquisition in both markets, but the effect is more prompt in China, where short selling was permitted for the first time. Investors acquire value-relevant information in both markets, primarily good news in the US and bad news in China, which helps improve short sellers’ trading profits. Lastly, information acquisition induced by the removal of short-sale constraints improves price efficiency in both markets. Our study provides direct empirical evidence that short-sale constraints affect stock prices by influencing the production of information.

Does Bilateral Investment Treaty Arbitration Have Any Value for Multinational Corporations?
Brada, Josef C.,Chen, Chunda,Jia, Jingyi,Kutan, Ali M.
Using event study methodology, we investigate whether bilateral investment protection treaties afford protection to foreign investors. Examining arbitral decisions for firms from six countries shows that firms that received awards from arbitrators gained in market value by as much as 3%. Per dollar awarded, firms gained over $20 in market value. Thus, we conclude that the system of arbitration does afford significant benefits to firms that can demonstrate that they have been injured by host governments who violated the terms of the relevant investor protection treaty. We also find some evidence that arbitral decisions are anticipated by stock markets.

Financial Regulation and Bank Supervision during a Pandemic
Ozili, Peterson K
Pandemics lead to a sudden decline in the level of economic activities. Lending institutions reduce credit supply to businesses due to fears of rising bad debts during a pandemic. This paper highlights some approach to financial regulation and bank supervision during a pandemic such as the SARS and COVID-19 pandemic. The approach suggested in this paper are intended to be applicable to all types of pandemic since their effect on banks and financial institutions are relatively the same.

Financing Nascent Industry: Leverage, Politics, and Performance in Imperial Russia
Gregg, Amanda G.,Nafziger, Steven
This paper explores the dynamics of corporate finance during the early stages of industrial growth by examining a newly constructed panel database of Imperial Russian industrial corporations’ balance sheets. We document large differences in financial strategies and outcomes across industries, over time, over firms’ life cycles, and between two Russian corporation types. Russian corporations’ profits and dividend payouts followed the Russian business cycle. Russian corporate debt ratios mostly follow modern capital structure theories, but tangible assets were not associated with higher debt levels, suggesting that Russian corporate debt was short-term, that collateral was irrelevant, or that agency problems dominated. We also find evidence that investors needed to be compensated for poor protections, since dividends were valued and widely-held corporations enjoyed greater returns. While the evidence suggests the presence of these and other frictions, our findings are consistent with the Imperial Russian financial system functioning well enough to enable early industrial development.

Firm Characteristics and Empirical Factor Models: A Model Mining Experiment
Tian, Mary H.
In a novel model mining experiment, we data mine hundreds of randomly constructed three-factor models and find that many outperform well-known models from the literature, including those with four and five factors. The results provide compelling evidence that the threshold of factor model success needs to be raised. Confidence intervals for model rankings, derived from a bootstrap simulation, offer new insights into the consistency of a model's pricing ability. Rankings for some well-known models are unusually volatile, which have wider confidence intervals than that of most of the random factor models.

Futures-Trading Activity and Jump Risk: Evidence From the Bitcoin Market
Zhang, Chuanhai,Ma, Huan
This paper examines the effects of futures trading on the jump risk in the Bitcoin market. We use a nonparametric method to detect Lévy-type jumps in Bitcoin prices and obtain jump risk measures (jump intensity and jump size) of big and small jumps by using 5-minute high-frequency data, and document that Bitcoin has obvious features of Lévy jumps, i.e., prices include both big jumps and small jumps, and the jump risk is time-varying. We then investigate the changes of these jump risk measures before and after the introduction of the Bitcoin futures, and we find that the jump size of big and small jumps decrease after the introduction of Bitcoin futures, while the big jump intensity increases. Further, we examine whether greater futures-trading activity (volume and open interest) is associated with greater Bitcoin jump risk and document that, on the one hand, there exists bidirectional causality between unexpected volume and jump intensity and size of Bitcoin and the impulse response function analysis show that the shocks have temporary increasing effects, and the speculative trading in the futures market will increase the jump risk. On the other hand, unexpected open interest Granger causes jump risk but the inverse is not true, indicating that investors are unlikely to hedge jump risk by using index futures. These findings disclose the fact that the hedging function of the Bitcoin futures does not work well and the functions of Bitcoin futures need to be further improved.

Government Guarantees and Bank Liquidity Creation Around the World
Berger, Allen N.,Li, Xinming,Saheruddin, Herman,Zhao, Daxuan
Governments provide guarantees to banks, such as deposit insurance, often increasing them during financial crises. While risk effects are well researched, impacts on bank output remain largely unexplored. We investigate bank output effects using data from 75 countries on bank liquidity creation, a comprehensive bank output measure. We address the reverse-causality identification challenge by examining effects of home country guarantees on liquidity creation by subsidiary banks in foreign host nations, and tackle omitted-variables concerns by specifying host country × year fixed effects. Our striking findings suggest that home-country guarantees increase decrease subsidiary bank liquidity creation by as much as 15%.

How Venture Capital Firms Evaluate Indonesian Start-Ups For Financing
Widyanto, Hanif,Dalimunthe, Zuliani ,Triono, Rachmadi Agus
This study discusses the investment evaluation criteria employed by venture capital firms in deciding to invest in potential Indonesian start-up companies. Based on the literature, we observed 12 investment evaluation criteria commonly used by venture capital firms (VCFs) around the world. In this study, we evaluate whether VCFs investing in Indonesian start-ups employ the same criteria. This research was conducted using a questionnaire that employed a Likert-scale of 1-4, applied correspondingly to the answers as irrelevant, desirable, important, and essential criteria. The unit of analysis is Venture Capital Firms (VCFs) investing in start-ups as business partners in Indonesia, mostly in the Jabodetabek and Bandung area. Study participants were representatives of VCFs who occupied a strategic position in the firms and were therefore able to understand the condition and point of view of each VCF. Out of the 35 VCFs accessed, 19 were willing to fill out the questionnaire. We found that six criteria are considered important in Indonesia. They are (a) capable of sustained intense efforts, (b) able to evaluate and react to risk well, (c) thoroughly familiar with the market the VCF targets, (d) demonstrated leadership ability in the past, (d) have a track record relevant to venture capital investment, and (t) the target market has enjoyed a significant growth rate. Meanwhile, the property right aspect is an important aspect in the USA, but not in Indonesia. Instead, VCFs require that the product demonstrates market acceptance and has been developed to the point of a functioning prototype.

Insolvency and debt overhang following the COVID-19 outbreak: Assessment of risks and policy responses
Demmou, Lilas,Calligaris, Sara,Franco, Guido,Dlugosch, Dennis,McGowan, Müge Adalet,Sakha, Sahra
This paper investigates the likelihood of corporate insolvency and the potential implications of debt overhang of non-financial corporations induced by economic shock associated with the outbreak of COVID-19. Based on simple accounting models, it evaluates the extent to which firms deplete their equity buffers and increase their leverage ratios in the course of the COVID-19 crisis. Next, relying on regression analysis and looking at the historical relationship between firms' leverage and investment, it examines the potential impact of higher debt levels on investment during the recovery. Against this background, the discussion outlines a number of policy options to flatten the curve of crisis-related insolvencies, which could potentially affect otherwise viable firms, and to lessen the risk of debt-overhang, which could slow down the speed of recovery.

Keeping Up with the Novaks? Income Distribution as a Determinant of Household Debt in CESEE
Stankeva Hake, Mariya,Poyntner, Philipp
This paper constitutes an initial attempt to shed light on the role of income distribution in household debt and financial market access in Central, Eastern and Southeastern Europe (CESEE). Using household-level data from the OeNB’s Euro Survey for the period 2009-2018, we address the question whether interpersonal comparisons (“keeping up with the CESEE Joneses" i.e. "the Novaks”) affect the probability of having and planning a loan. Applying multilevel probit modeling to take into account the hierarchical structure of the data, our results support the notion that higher income inequality is negatively correlated with the probability of having a loan at the bottom of the distribution, and positively at the top. We show this impact for almost all components of household debt, but evidence is strongest for mortgage, car and foreign currency loans. Interpersonal comparisons turn out to drive loan intentions, however, mainly on the very top of the income distribution.

Political Cycles and Bank Lending in Russia
Fungáčová, Zuzana,Schoors, Koen,Solanko, Laura,Weill, Laurent
State-owned banks tend to increase lending before elections for the purpose of boosting the reelection odds of incumbent politicians. We employ monthly data on individual banks to study whether Russian banks increased their lending before presidential elections during 2004â€"2019, a period covering four presidential elections. In contrast to the literature, we find that both state-owned and private banks increased their lending before presidential elections. This result stands for all loans, as well as separately for firm and household loans. The pre-election lending surge is followed by a deterioration of loan quality the following year, indicating the lending increase was not driven by higher growth prospects or some positive economic shock. The effect is substantially greater for large banks and banks more involved in lending activities. Our main finding that all types of banks in Russia increase their lending before presidential elections supports the view that the authorities in an electoral autocracy like Russia can influence lending of both private and state-owned banks for political reasons.

Regulatory Arbitrage and Global Push Factors
Avdjiev, Stefan,Aysun, Uluc,Tseng, Michael
This paper identifies two theoretical mechanisms that relate the regulatory arbitrage behavior of internationally active banks (IABs) to global financial conditions. According to the first mechanism, regulation becomes more binding during adverse financial conditions. Under these conditions, IABs face higher compliance costs in more regulated markets. According to the second mechanism, higher regulation suppresses the degree of risk-taking and asset returns so that highly-regulated nations are more insulated from global financial risk. These results are reversed in less-regulated nations. We use a panel of bilateral BIS banking statistics and a unique empirical strategy to find that the first of the two theoretical mechanisms above is more prevalent. Specifically, IABs expand their claims more rapidly in less-regulated nations when global perception of financial risk is higher. The direction of arbitrage is reversed under loose conditions. This evidence is corroborated by the inferences from a structural vector autoregressive model fitted to data from individual countries.

Sex, Language, and Financial Inclusion
Osei-Tutu, Francis,Weill, Laurent
Reference to gender in language can lead individuals to draw distinctions between genders and reinforce traditional views of gender roles. To test our hypothesis that language gender-marking exerts an influence on the gender gap in financial inclusion, we draw on data for 117 countries in the World Bank’s Global Findex database and perform logit estimations at the individual level. We find the gender gap in the probability of owning a formal account, having access to a formal credit, as well as having savings in a formal financial institution is higher for countries with gendered languages than for countries with genderless languages. These findings are confirmed in robustness checks that control for alternative measures of culture and estimations at the country level.

Sustainability of Direct Lending: Evidence from Index Exclusion
Davydiuk, Tetiana,Marchuk, Tatyana,Rosen, Samuel
The 2006 change in the disclosure requirements for "Acquired Fund Fees and Expenses" (AFFE) led to the exclusion of business development companies (BDCs) from major stock indexes in 2014, constituting a contractionary shock to the flow of equity capital into publicly traded BDCs. In a difference-in-differences setting, we demonstrate that AFFEcted BDCs â€" those with high pre-shock mutual fund ownership â€" experience a 10%-14% larger drop in their equity growth and 12%-16% larger decline in investment growth relative to non-AFFEcted BDCs. These findings highlight the importance of access to capital markets for BDCs to sustain their investment activities. Exploiting the geographic dispersion of BDC borrowers, we further document the negative impact of the AFFE regulation on local employment growth.

The Difference between Modiglianiâ€"Miller and Milesâ€"Ezzell and its Consequences for the Valuation of Annuities
Becker, Denis M.
This paper addresses the differences between the Modigliani-Miller [M&M] model (1958, 1963) and the Miles-Ezzell [M&E] model (1980, 1985). The main difference between these two models concerns the stochasticity of the free cash flows. While M&M assume a strictly stationary process, M&E’s process is a martingale. However, this subtle difference has not been fully exposed, and previous literature has produced partly erroneous statements or inconsistent valuation models. Therefore, the main objective of this paper is to illustrate and accentuate the effect of these two mutually exclusive stochastic processes on the timely behavior of cash flows, discount rates, and values of the firm, equity, debt and tax shield. For this purpose, we perform a numerical experiment that allows the determination of values and discount rates by means of the risk-neutral approach. We show that in the M&E model, all cash flows and values are path-dependent, while they are not in M&M’s world. Furthermore, in M&E’s model all discount rates are time-invariant, except for the discount rate applied to tax shields, which depends on the lifetime of the cash flows. Contrary, in the M&M setup, all discount rates change across time, except for the constant discount rate of the tax shield. This has consequences for the applicability of the well-known present-value formula for annuities and for building consistent valuation models for both finite and perpetual cash flows.

The EURIBOR and EONIA Reform: Achieving Regulatory Compliance While Protecting Financial Stability
Priem, Randy,Van Rie, Ward
This article describes the events leading up to the EURIBOR reform and the efforts to make EURIBOR compliant with the European Benchmark Regulation. It also explains the actions undertaken to transition from EONIA towards €STER and the reasoning behind the choice to recalibrate EONIA into €STER plus a spread. Although EURIBOR is considered BMR-compliant since 2 July 2019 and EONIA can continue to be used until 3 January 2022, this article explains why market participants should not be dis-incentivized to already take actions to provide for fallback rates to EURIBOR in their legal documentation, and to move away from EONIA.

The Effect of Lender’s Protection on Online Peer-to-Peer Lending in Indonesia
Amalia, Nur,Dalimunthe, Zuliani ,Triono, Rachmadi Agus
This study aims to analyze how lender protection for default risk provided by peer to peer lending platform (P2P) effect to prospective lenders’ lending intentions in Indonesia, and use platform trust as the mediating variable. We collected and summarized protection terms provided by P2P platform through examined 17 platforms websites and interview two platforms’ management. We also survey 303 respondents accessed through online questionnaire. Analysis of this study used Path Analysis of Structural Equation Model (SEM) method run with LISREL software. Respondents are prospective lenders who familiar with P2P Lending concept and some of them are real lenders. We found that there are several policy perceived as protection for lenders, such as having SLIK checking, using machine learning technology to record and analyze loan, joining in international forums related to credit risk management and collaborate with financing company to overcome the risk of shortage fund. We also found that the peer to peer lending platform should be able to build lender trust by making lenders feel protected to invest on the platform despite the possibility of default risk. We suggest that Financial Services Authority (called OJK) may create protection policies to protect lenders in the market like Indonesian Securities Protection Fund (ISPF).

The Effect of the China Connect
Ma, Chang,Rogers, John H.,Zhou, Sili
We document the effect on Chinese firms of the Shanghai (Shenzhen)-Hong Kong Stock Connect. The Connect was an important capital account liberalization introduced in the mid-2010s. It created a channel for cross-border equity investments into a selected set of Chinese stocks while China’s overall capital controls policy remained in place. Using a difference-in-difference approach, and with careful attention to sample selection issues, we find that mainland Chinese firm-level investment is negatively affected by contractionary U.S. monetary policy shocks and that firms in the Connect are more adversely affected than those outside of it. These effects are stronger for firms whose stock return has a higher covariance with the world market return and for firms relying more on external financing. We also find that firms in the Connect enjoy lower financing costs, invest more, and have higher profitability than unconnected firms. We discuss the implications of our results for the debate on capital controls and independence of Chinese monetary policy.

The Effectiveness of Linkage Programs: Case Study of BMTs in Indonesia
Fitriasari, Triani,Dalimunthe, Zuliani
Despite the importance of microfinancing as a tool for alleviating poverty, formal financial institutions, such as banks, are reluctant to provide this type of financing. There is, therefore, a need to provide financing indirectly through linkage programs. Launched by Bank Indonesia on January 9, 2004, the linkage program is the first pillar of the Indonesian Banking Architecture, and serves as a comprehensive framework for the development of the Indonesian banking industry. The program provides financing through cooperatives to their members operating microbusinesses. This study was conducted to evaluate the effectiveness of linkage programs provided by Islamic banks for microfinancing through Islamic cooperatives known as houses of charity (baitul maal wa tamwil, BMT). This research was conducted by using a mixed qualitative and quantitative approach. Qualitative information was collected using in-depth interviews with the management and authorized officers from five BMTs that are knowledgeable about such cooperatives. The quantitative research was conducted by analyzing the cooperatives’ financial statements and conducting a direct survey of the recipients of financing. The effectiveness of a microfinancing program is commonly measured by three aspects, known as the “the triangle of microfinance.” These aspects are the extent to which the financing provides for the poor (outreach), whether it increases the income or assets of the target population (impact), and the business survival of institutions managing the financing (institution sustainability). We found that linkage programs had a positive impact, especially on improving the affordability of outreach in small and medium-sized but not in the large BMTs. We suggest that the Indonesian Bank or Indonesian Financial Service Authority should specifically encourage medium-sized cooperatives or BMTs to employ this program by providing more incentives for banks or reducing the barriers for BMTs to participate.

The Failure of Chinese Peer-to-Peer Lending Platforms: Finance and Politics
He, Qing,Li, Xiaoyang
We investigate the influence of financial and political factors on peer-to-peer (P2P) platform failures in China’s online lending market. Using a competing risk model for platform survival, we show that large platforms, platforms with listed firms as large shareholders, and platforms with better information disclosure were less likely to go bankrupt or run off (platform owners abscond with investor funds). More importantly, failing platforms were much less likely to run off in advance of major political events, but more likely to declare bankruptcy or run off after such events. These effects are more pronounced for politically connected platforms, platforms operating in provinces where local officials have close ties with central government, and in provinces with better local financial conditions. Our study highlights the role of political incentives on government regulatory intervention in platform failures.

The Vanishing Interest Income of Chinese Banks
Kauko, Karlo
Chinese banks likely have more non-performing loans (NPLs) than officially reported. As hidden NPLs earn no interest income, loan quality problems may erode the gross interest income of banks. Using stochastic frontier analysis, we estimate the interest income of a hypothetical profit-maximising Chinese bank with no credit quality problems. Taking the deviation of actual interest income from the calculated efficient income, we then attempt to reveal the amount of hidden NPLs in Chinese banks. Our results uncover a substantial weakening in the quality of Chinese bank loan portfolios in 2016. Big banks are found to have the largest reservoirs of hidden NPLs. Dependence on interbank funding also seems to be a determinant in the size of hidden NPL portfolios.

Variance Discount Rates: What Drives Preferences over Variance Risk?
Koëter, Joren
I study time-variation in variance discount rates, defined as the expected returns for investing in variance risk. I show that variance discount rates drive a significant fraction of the variation in prices of S&P 500 variance swaps. This analysis offers important insights into preferences of investors over variance risk. I decompose variation in prices into variation due to variance expectations and variation due to variance discount rates. Variance expectations drive most of the variation in short-term variance swaps, whereas variance discount rates drive most of the variation in long-term variance swaps. I show that prominent asset pricing models, in which variation in the equity premium originates from variation in variance risk, have profoundly different predictions regarding the behavior of variance discount rates. None of the models analyzed are able to match the empirical properties of variance discount rates.