Research articles for the 2021-02-26

Are Stock Returns and Output Growth Higher Under Democrats?
Fair, Ray C.
Recent literature suggests that both stock returns and economic growth are significantly higher under Democratic presidential administrations. This is a puzzle in that persistent differences in stock returns seem unlikely in efficient markets, and it is not obvious why Democrats should do better. Often these kinds of results go away upon further analysis or more data, and this appears to be true in the present case. In this paper the sample is extended to 27 administrations, from Wilson-1 through Trump. While the mean stock return under the Democrats is generally higher, none of the differences in means are significant at conventional significance levels. There is considerable variation in the mean return across administrations, which results in lack of significance. Similarly, while the mean output growth rate under the Democrats is larger, the difference is not significant. Again, there is considerable variation in output growth across administrations. Results are also presented with the ten administrations between Grant-2 and Taft added, a total of 37 administrations. While the added data are likely not as good, the conclusion is the sameâ€"no significant differences.

Copy-Paste Outperformance: Lazy Investors and Copied Reports
Sadlo, Sven
Cohen, Malloy, and Nguyen (2020) show that year-over-year changes in annual and quarterly reports of US firms significantly predict future returns: ”changers” generate negative alpha and underperform ”no changers” considerably. I replicate this anomaly for an updated and investable sample of S&P 1500 constituents between 1996 and June 2020 (3,668 firms, 208,425 reports). The quintile of firms with least similar reports still generates negative 3- and 5-factor alpha of up to -5.12% per year. In contrast to Cohen et al. (2020), I find a pronounced asymmetry: ”changers” underperform but ”no changers” do not outperform. The prevailing explanation is inattention: ”lazy” investors apparently do not read reports carefully and fail to spot important changes. I provide novel evidence for this argument, as ”changers” continue to underperform in the attention-grabbing universe of S&P 500 firms. Given that ”changers” earn lower future margins and returns on invested capital, these results challenge semi-strong market efficiency for probably the most widely followed stocks in the world.

Fear and Risk: Do Visceral Factors Affect Risk Taking?
Bogan, Vicki L.,Yonker, Scott E.
We provide empirical evidence that visceral factors affect financial risk taking by showing that exposure to mass shootings alters mutual fund managers' risk taking decisions. Funds that are exposed to mass shootings subsequently decrease risk relative to their peers. The effect that we document is temporary, lasting approximately one quarter before reverting to normal levels and is strongest among managers with demographics shown to express greater fear from mass shootings. Together with the literature on laboratory studies that show that market downturns induce fear, our findings suggest that fear could exacerbate variation in risk taking, generating the highly volatile countercyclical risk premiums shown to exist in markets.

Financial Reporting Fraud and Delegated Investment
Davidson, Robert H.,Pirinsky, Christo A.,Zhang, Hanjiang
Following the public revelation of financial reporting fraud against a company in their portfolio, professional money managers decrease (increase) their holdings in stocks with high (low) expected financial reporting fraud risk, reduce the total risk level of their funds, and allocate their portfolios closer to their respective benchmarks. Portfolio managers exposed to financial reporting fraud rely less on accounting information in their trading decisions subsequently, suggesting that fraud alters the behavior of investment managers by reducing their trust in security issuers. The results provide insight into the implications of fraud for professional investment decisions.

Fire Sale Risk and Credit
Bongaerts, Dion,Mazzola, Francesco,Wagner, Wolf
This paper examines whether the risk of a future collateral fire sale affects lending decisions. We study US mortgage applications and exploit exogenous variation in foreclosure frictions for identification. We find lenders to be less likely to approve mortgages when anticipated losses due to uncoordinated collateral liquidations are high, and when there is elevated risk of joint collateral liquidation. These results suggest that fire-sale risk has implications for credit allocation, and that lenders' collective origination decisions mitigate fire sale risk ex-post. However, we also find the effects to be significantly weaker outside periods in which fire sales are salient.

Hiding Filthy Lucre in Plain Sight: Theory and Identification of Business-Based Money Laundering
Maskus, Keith E.,Peri, Alessandro,Rubinchik, Anna
Proceeds from illicit activities percolate into the legal economy through several channels. We exploit international regulations targeting money laundering via the financial sector to identify the flows of “dirty money” into legitimate establishments: business-based money laundering (BBML). Our variant of the monopolistic competition model embeds a drug cartel that channels illicit proceeds into an offshore financial investment and into BBML. Tighter regulations in one channel increase the flow in the other. We use a research design that links U.S. county business activity to the evolution of anti-money-laundering regulations in Caribbean jurisdictions to provide the first empirical evidence of the phenomenon.

Identifying the Effect of Stock Indexing: Impetus or Impediment to Arbitrage and Price Discovery?
Ahn, Byung Hyun,Patatoukas, Panos N.
The rise of stock indexing has raised concerns that index investing impedes arbitrage and degrades price discovery. This paper uses Russell’s reconstitution to identify the causal effect of index investing on information arbitrage and price discovery. While index investing has no discernible effect on the ability of arbitrageurs to trade and impound news into the prices of large- and mid-cap stocks, we find that index investing increases the speed of price adjustment to news for micro-cap stocks. Our causal evidence identifies the relaxation of arbitrage constraints as a mechanism through which indexing facilitates informed trading for more arbitrage-constrained micro-cap stocks.

Idiosyncratic Return Volatility and the Role of Firm Fundamentals: A Cross-Country Analysis
Ebrahimnejad, Ali,Hoseinzade, Saeid
We investigate the relation between fundamental idiosyncratic volatility and stock returns idiosyncratic volatility using data from 56 countries over 1980-2014. We find a strong positive relation between fundamental idiosyncratic volatility and idiosyncratic volatility of returns. This association, however, seems to be entirely concentrated in the developed economies and we find no effect in the emerging markets. Specifically, fundamental idiosyncratic volatility does not lead to more idiosyncratic return volatility in countries with poor legal institutions and weak shareholder protection laws.

Individualized Exams
Yan, Yuxing
Usually my exams consist of two parts: multiple-choice questions (MC), and problems, such as 20 MCs and 3 problems. In this paper, I show how to generate individualized exams for 35 students. Based on the first name and the last 2 digits of a student’s ID, every student gets his/her one-line R code. To start an exam, simply copy-and-paste it to the R console. Based on seven input files, my functions automatically generate 35 exams. To grade MCs, copy the answers first, run one program, and then paste the grades back to Excel. One beauty of this method is that instructors and students are not required to have any prior knowledge related to R, which is free. Such an individualized exam with Zoom monitoring might be a good way to hinder potential cheating for an online exam.

Information in Financial Contracts: Evidence from CMBS Pooling and Servicing Agreements
Ambrose, Brent W.,Han, Yiqiang,Korgaonkar, Sanket,Shen, Lily
We introduce a novel application of machine learning to compare the Pooling and Servicing Agreements (PSA) that govern asset-backed securities. The PSA is often viewed as mostly boilerplate legal text and thus may appear similar across deals despite heterogeneity in the underlying collateral and deal structures. Our empirical setting is PSAs governing commercial mortgage-backed securities (CMBS). After documenting variation in PSAs, we find that underwriters tailor the PSAs to reflect the differences in the collateral pool as well as the macroeconomic environment prevailing at security origination.

Insider Stock Pledges and Shareholder Wealth
Pan, Xiaofei,Qian, Meijun
While pledging shares as collateral for personal loans is commonly practiced in many countries that protect minority shareholders, the empirical evidence has shown only its value destruction to shareholders. This paper offers an (partial) explanation of this puzzle by documenting a positive shareholder wealth effect of this practice. We find sizeable, significant, and positive stock market reactions to the regulation that facilitates share pledges (2.17%, 87 billion USD) and the effect is larger for (32~43 bps) for financially constrained firms and firms whose controlling shareholders have more shares to pledge. Similar effects are found for pledge transactions and the reverse for the regulation that reduces share pledges. Financial constraint and controlling ownership jointly determine the share pledge purpose to finance listed firms. Following pledge transactions with the purpose of financing listed firms (to purchase shares or for consumption), inter-corporate borrowing increases (insider ownership increases or decreases), and the CARs upon disclosures are significantly positive (negative). While the ratio of shares pledged is positively associated with crash risk, we find that pledging shares for the purpose of financing is negatively associated with crash risk.

Pursuing Multiple Premiums: Combination vs. Integration
Dai, Wei,Saito, Namiko,Watson, Stephen
This paper compares two different approaches to pursue multiple premiums: a combination approach (market portfolio plus factor portfolios) and a fully integrated approach. We evaluate the two approaches via multiple lenses: pursuit of higher expected returns, distribution of over- and underweights, turnover, and costs. Our analysis shows the integrated approach can lead to greater reliability of outperformance, better risk control, and lower costs. These benefits are critical to an efficient pursuit of multiple premiums and cannot be replicated through combination approaches.

Smart Derivatives Contracting: Automating Interest Rate Swaps in the Over-the-Counter (OTC) Market with the DAML
Oluwajebe, Olusegun,Duah, Mary,Golnikova, Polina
The over-the-counter (OTC) market sees the majority of trading volume in the finance industry, yet it remains vastly unregulated. Inherent to its nature are issues with transparency, efficiency and security, which have been barely addressed by legislators post the 2008 crisis. We propose that the utilization of Smart Contracts in the OTC market and creation of “smart derivatives”, solves the majority of issues that are associated with the market. While other researchers have debated on this matter and proposed the use of Smart Contracts in OTC markets, there are no papers offering an example of practical implementation. We selected interest rate swaps (IRS) as the test-case derivative for implementation in the form of a smart contract. Having unpacked the mathematical and theoretical framework behind structuring and pricing IRS, we produced a Vasicek Simulated Yield Curve from the Ten Year Constant Maturity Treasury Rates and found that the curve was inverted, which, combined with a characteristic LIBOR Simulated Yield Curve pointed to an increasingly negative swap spread for longer maturities that was demonstrated with a plotted Swap Spread. The parameters of the model were derived from live market data through Maximum Likelihood Estimation with Monte Carlo Simulation of Euler Scheme discretized Vasicek instantaneous rates. We concluded that short term interest rate swap contracts were preferable and implemented a one-year Interest Rate Swap by instantiating the DAML Ledger Sandbox. The implementation offers the likely innovation of merging a Swap Execution Facility and a Swap Data Repository into one platform, ensuring end-to-end automation, as well as providing the benefits of visibility, while preserving anonymity, improving efficiency and security in the market.

The Cross-section of Long-run Expected Stock Returns
Geertsema, Paul,Lu, Helen
Abstract We predict cumulative stock returns over horizons from 1 month to 10 years using a tree-based machine learning approach. Cumulative stock returns are significantly predictable in the cross-section over all horizons. A hedge portfolio generates 250 bp/month at a 1 year horizon and 110 bp/month at a 10 year horizon. Individual stock returns are significantly predictable at all horizons in panel data. Cashflow and momentum related predictors are mostly important at shorter horizons while dividend yield and value related predictors are more important at longer horizons. By contrast, variables related to turnover and volatility are influential at all horizons.

The Effect of Stock Ownership on Individual Spending and Loyalty
Medina, Paolina C.,Mittal, Vrinda,Pagel, Michaela
In this study, we quantify the effects of receiving stocks from certain brands on spending in the brand's stores. We use data from a new FinTech company called Bumped that opens brokerage accounts for its users and rewards them with stocks when they shop at previously elected stores. For identification, we use 1) the staggered distribution of brokerage accounts over time after individuals sign up for a waitlist and 2) randomly distributed stock grants. We find that individuals spend 40% more per week at elected brands and stores after being allocated an account. In response to receiving a stock grant, individuals increase their weekly spending by 100% on the granted brands. Beyond documenting a causal link between stock ownership and individual spending, we show that weekly spending in certain brands of our users is strongly correlated with stock holdings of that brand by Robinhood brokerage clients. Finally, we present survey evidence to argue that loyalty is the dominant psychological mechanism explaining our findings. We thus provide micro evidence for the idea that brand loyalty is an intangible asset that leads to lower cash flow volatility.

The Sustainability of (Global) Withdrawal Strategies
Estrada, Javier
The most important financial issue retirees have to deal with is whether their strategy will be able to sustain all the withdrawals they expect to make in retirement, as well as a bequest they aim to leave. For this reason, it is critical to periodically monitor the evolution of a financial plan in order to detect early signs of trouble, which may lead a retiree to introduce dynamic adjustments to a strategy. To that purpose, this article features two tools, a sustainability test and the sustainable withdrawal, and shows how to apply them. It also discusses the empirical evidence on both tools based on a comprehensive sample of 22 countries over a 120-year period.

Turning Tail Risks into Tailwinds
Gava, Jerome,Guevara, Francisco,Turc, Julien
This study compares a broad range of risk models for managing multi-asset portfolios. The investment universe is extended to a range of systematic strategies with varying risk and return profiles. Focusing on risk parity portfolios, it is shown that considering tail risks can successfully reduce negative asymmetry and sharp losses. Extreme risk theory is of particular help in finding the right allocation to defensive systematic strategies in the portfolio.

Voting Rights and the Delayed Stock Price Response to Option Information
Li, Gang,Zhang, Linti,Zhang, Shaojun
Recent studies find that transactions volume and volatility spread of exchange-traded single-stock options predict the underlying stock’s future returns. Most of the firms with exchange-traded options have large market capitalization and are actively traded. It is a puzzle why it takes days and sometimes weeks for stock price to reflect the information contained in option trades. We conjecture that voting rights consideration may contribute to the delayed stock price response to option information. More specifically, we hypothesize that the delay is much longer during the period when shareholder voting is required to resolve contentious corporate matters. We analyze a sample of 1,842 special shareholder meetings between 2003 and 2015 and find that the predictability of option volume and volatility spread is much stronger in the weeks around special shareholder meetings (i.e., the event window). The Fama-MacBeth regression analysis shows that while the predictability of volatility spread is significant both within and outside the event window, the predictability of option volume is significant only within the event window. We contribute to the literature by offering a new explanation of the delayed stock price response to option information and documenting a significant asset pricing effect of voting rights.

When it Rains, it Pours: Multifactor Asset Management in Good and Bad Times
Briere, Marie,Szafarz, Ariane
We examine the profitability of multifactor portfolios on the U.S. stock market. Using passive sector investing as the benchmark, we assess the performances of factor-based asset management strategies in good and bad times. When short selling is unrestricted, factor investing outperforms sector investing in all respects. For long-only portfolios, our results reveal a trade-off between the risk premia associated with factors and the diversification potential of sectors. Multifactor investing tends to be more profitable than the benchmark during good times but less attractive during bad times, when diversification is needed the most.

김정은 시대 북한의 금융제도 ë³€í™" - 북한 문헌 분석을 ì¤'심으로 - (Changes in North Korea’s Financial System During the Kim Jong-un Era - Based on North Korean Literature)
Kim, Minjung,Mun, Sungmin
Korean Abstract: 본고ëŠ" 김정은 ì§'권 이후 ì¶"진된 금융부문에서의 개혁조치에 주목하여 ê·¸ ë³€í™"의 내용을 북한 문헌을 ì¤'심으로 분석하고 개혁수준을 평가하였다. 분석 ê²°ê³¼, 김정은 ì§'권 이후 북한은 ì¤'앙은행과 상업은행이 조직적·기능적으로 분리된 것으로 나타났다. 또한 기업은 은행계좌에서의 현금 인출 및 기업간 현금결제가 허용되ëŠ" ë"± 종전의 무현금 í™"폐가 수동적 í™"폐(passive money)에서 구매력이 있ëŠ" 능동적 í™"폐(active money)ë¡œ 일부 기능 í•  수 있게 되었다. ì¤'앙은행과 상업은행이 조직적·기능적으로 분리됨에 ë"°ë¼ ì¤'앙은행의 발권이 상업은행을 통한 í™"폐공급 방식으로 ë³€í™"되었으며, í™"폐유통구조의 ë³€í™"도 함께 이루어져 상업은행의 신용창조 기능이 구현될 수 있게 되었다. 종합해보면, 사회주의계획경제의 은행 및 í™"폐·지급결제제도가 시장경제의 방식으로 ë³€í™"되고 있음을 의미한다. 금융부문에서의 개혁은 제반 경제제도 ë³€í™"를 ë'·ë°›ì¹¨í•˜ê³  공금융의 기능 회복을 위해 í•„ìš"했던 것으로서 개혁수준의 측면에서ëŠ" 진일보한 것이나, 아직 ê·¸ 수준은 사회주의 ì²´ì œ 내에서의 ë³€í™"인 과거 구소련의 페레스트로이카 시기 또ëŠ" ì¤'국의 개혁개방 초기와 유사한 것으로 평가되었다. 또한, 계획경제 유지 ë"±ì˜ 제도적 제약ìš"인과 공금융에 대한 신뢰 ê²°ì—¬ ë"±ì€ ë³€í™"된 금융제도의 실효성 및 발전성을 제한할 것으로 평가되었다. 본고의 분석결과ëŠ" 북한에서 발간된 문헌에 기초하고 있다ëŠ" 점에 유의할 í•„ìš"ê°€ 있다. 즉, 최근의 ë³€í™"ê°€ 김정은 ì§'권 이후의 청사진으로 일부 지역에서 ì‹œë²"적으로 ì¶"진된 것인지, 전면적으로 ì¶"진되고 있ëŠ"지에 대한 실상은 설명하지 못한다ëŠ" 한계가 있다.English Abstract: This paper analyzes the changes in financial reform during the Kim Jong-un era based on North Korean literature. We find that North Korea has systematically and functionally separated the central bank from commercial banks since the Kim Jong-un era began. In addition, enterprises have been allowed to withdraw cash from bank accounts and make inter-enterprise cash payments. In other words, nowadays non-cash currencies with passive money can partially serve as active money with purchasing power. With the systematic and functional separation of the central bank and the commercial bank, the issuance of the central bank changed to a money supply method through the commercial bank, and changes in the currency distribution structure have allowed commercial bank’s credit creation function to be implemented. This means that the banking system and the monetary·payment system of the socialist planned economy are changing in the way of the market economy. Reforms in the financial sector are believed to have been necessary to support changes in the economic system and to restore the function of the public financial sector. These changes have progressed in terms of the level of reform, but they are still considered similar to the period of the former Soviet Union's Perestroika or to the early period of China's reform and opening. In addition, it is assessed that institutional constraints such as maintaining a planned economy, and the lack of confidence in public finances limit the effectiveness and development of the financial system. It should be noted that these results are based on literature published in North Korea. In other words, there is a limit in the fact that such recent changes have been carried out on a trial basis in some areas, or have been carried out in a full-scale manner with a blueprint, since Kim Jong-un's inauguration.