Research articles for the 2021-03-12

A Dynamic Semiparametric Characteristics-based Model for Optimal Portfolio Selection
Connor, Gregory,Li, Shaoran,Linton, Oliver B.
This paper develops a two-step semiparametric methodology for portfolio weight selection for characteristics- based factor-tilt and factor-timing investment strategies. We build upon the expected utility maximization framework of Brandt (1999) and Aït-sahalia and Brandt (2001). We assume that asset returns obey a characteristics- based factor model with time-varying factor risk premia as in Li and Linton (2020). We prove under our return- generating assumptions that in a market with a large number of assets, an approximately optimal portfolio can be established using a two-step procedure. The first step finds optimal factor-mimicking sub-portfolios using a quadratic objective function over linear combinations of characteristics-based factor loadings. The second step dynamically combines these factor-mimicking sub-portfolios based on a time-varying signal, using the investor’s expected utility as the objective function. We develop and implement a two-stage semiparametric estimator. We apply it to CRSP (Center for Research in Security Prices) and FRED (Federal Reserve Economic Data) data and find excellent in-sample and out-sample performance consistent with investors’ risk aversion levels.

A Look At Sustainable Development In Kenya: An Analysis Of Environmental, Natural Resources, Health And Infrastructure Governance
Kimani, Edwin
Since attaining independence, Kenya has been keen on development. Recently, the development discourse in Kenya has adopted sustainable development sentiments by adopting the concepts of sustainable development within its development frameworks. This is due to the realization that whilst striving to fulfill the needs and aspirations of the current generation, it must also guarantee the ability of future generations to meet their needs. This research discusses the challenges bedeviling the attainment of sustainable development in Kenya through the lenses of gender, environmental and natural resource governance, infrastructure as well as food security. These themes have been debated a lot, without yielding a consensus on the suitable approach to sustainable development. This has resulted to more abstract development frameworks whose legal status is unclear. This chapter posits that the ideas and frameworks of sustainable development in Kenya are not well articulated, have no proper legal standing and do not bind on the government. It concludes that there should be a paradigm shift from statements of intention to a sound, inclusive and binding framework that guides successive governments.

A Theory of Debt Maturity and Innovation
Mitkov, Yuliyan
I propose a theory of debt maturity as an incentive device to motivate innovation when contracts are fundamentally incomplete and shaped by ex-post renegotiation. The financing of innovative firms must balance two goals. On the one hand, since innovation is inherently risky, the entrepreneur must receive adequate protection after failure. Simultaneously, the firm must be liquidated when its assets can be redeployed more efficiently elsewhere. Meeting these two goals can be especially challenging when contracts are incomplete. I show how an appropriate choice of debt maturity, together with ex-post contract renegotiation, embeds a "put option" into the firm's capital structure. The put is exercised when liquidation is efficient, and it partially insures the entrepreneur against failure and thus motivates innovation. The theory has novel empirical implications for the financing patterns of innovative firms.

Association Between Financial Planning and Professional Advice â€" Do They Co-Exist?
Dam, Leena,Hotwani, Malti
Financial planning is a skill which is required to manage one’s money, achieve financial goals through wealth accumulation along with a perfect balance to meet daily financial requirements. Due to wide variety of products available in financial service sector, individuals need to be financially literate in order to make realistic financial plans and decide the best suited investment product where returns beat inflation and accumulation is achieved. The best way to achieve one’s financial objectives is through proper financial planning keeping in mind individual’s income, saving capabilities and risk appetite. This study attempts to analyze the relationship between income and financial planning. The paper further examines whether individual seek professional advice for personal financial planning. The findings suggest that majority of individual have set financial goals. But on the other hand, majority of individuals don’t have set financial plan. Also majority of individuals are not satisfied with their financial decisions. The results emphasize on the need for seeking professional advice for personal financial planning.

Conditional Value at Risk and Partial Moments for the Metalog Distributions
Khokhlov, Valentyn
The metalog distributions represent a convenient way to approach many practical application. Their distinctive feature is simple closed-form expressions for quantile functions. This paper contributes to further development of the metalog distributions by deriving the closed-form expressions for the Conditional Value at Risk, a risk measure that is closely related to the tail conditional expectations. It also addressed the derivation of the first-order partial moments and shows that they are convex with respect to the vector of the metalog distribution parameters.

Bryzgalova, Svetlana,Julliard, Christian
Using information in returns we identify the stochastic process of consumption â€" the crucial ingredient of most macro-finance models. We find that aggregate consumption reacts over multiple quarters to innovations spanned by financial markets, and this persistent component accounts for 26% of the consumption variation. These innovations drive most of the time series variation of equity returns and are priced in the cross-sections of both bonds and stocks. The data rejects the hypothesis that the stochastic volatility of consumption is proportional to market volatility, and that either of them is priced, posing a novel challenge for consumption-based asset pricing models.

Corporate Governance Analysis on Risk Exposure and Performance of AIA Bhd.
Annathurai, Anusha
Analysis on corporate governance principles of AIA Bhd. is studied in this article along with their risk exposure and performance as per the concern of the research objective. The performance of the company is indicated by Return on Asset which act as the dependent variable of this study. Whereas, the risk exposure is indicated by internal and external factors of independent variables. Internal factors cover Liquidity Risk in terms of current ratio and quick ratio; Credit Risk in terms of average collection period and debt to income ratio; and Operational Risk in terms of operational ratio and operating margin. Meanwhile, external factor covers Market Risk in terms of Gross Domestic Product (GDP) rate, Inflation Rate, Interest Rate and Exchange Rate. The analysis of this study shows that the influence of these independent variables is significant towards the dependent variable. The analysis concluded that the most significant variable is Operating Margin.

Corporate Zombies: Anatomy and Life Cycle
Banerjee, Ryan
Using firm-level data on listed non-financial companies in 14 advanced economies, we document a rise in the share of zombie firms, defined as unprofitable firms with low stock market valuation, from 4% in the late 1980s to 15% in 2017. These zombie firms are smaller, less productive, more leveraged and invest less in physical and intangible capital. Their performance deteriorates several years before zombification and remains significantly poorer than that of non-zombie firms in subsequent years. Over time, some 25% of zombie companies exited the market, while 60% exited from zombie status. However, recovered zombies underperform compared to firms that have never been zombies and they face a high probability of relapsing into zombie status.

Currency Risk Premia Redux
Nucera, Federico,Sarno, Lucio,Zinna, Gabriele
We study a large currency cross section using recently developed asset pricing methods. First, we show that the implied pricing kernel includes three latent factors: a strong U.S. `Dollar' level factor, and two weak, high Sharpe ratio `Carry' and `Momentum' slope factors. The evidence for an additional 'Value' factor is scant. Second, based on this pricing kernel, we obtain robust estimates of the risk premia of more than 100 non-tradable risk factors. Some of these factors -- mostly relating to volatility, uncertainty and liquidity conditions in currency and other markets -- are priced, disclosing a clear nexus across asset classes.

Customer Concentration and Speed of Capital Structure Adjustments
Rehman, Obaid Ur,Liu, Xiaoxing,Wu, Kai,Zhu, Ziyan
We examine whether and how commitment to major customers affects the speed of adjustment (SOA) to achieve its target capital structure. We find a negative association between the degree of customer concentration (CC) and supplier firm’s SOA, especially in overleveraged firms. The negative association is more pronounced in firms with financial constraints and liquidity pressure, low market share, and low cost in private information acquisitions. Besides, the adverse impact of CC on SOA is stronger when the suppliers are engaged in high relationship-specific investments. Finally, we identify the management earnings forecast as a mediating channel between CC and SOA. Our findings demonstrate that concentrated customers reduce the supplier firm’s SOA due to customer commitments.

Deep Structural Estimation: With an Application to Option Pricing
Chen, Hui,Didisheim, Antoine,Scheidegger, Simon
We propose a novel structural estimation framework in which we train a surrogate of an economic model with deep neural networks. Our methodology alleviates the curse of dimensionality and speeds up the evaluation and parameter estimation by orders of magnitudes, which significantly enhances one's ability to conduct analyses that require frequent parameter re-estimation. As an empirical application, we compare two popular option pricing models (the Heston and the Bates model with double-exponential jumps) against a non-parametric random forest model. We document that: a) the Bates model produces better out-of-sample pricing on average, but both structural models fail to outperform random forest for large areas of the volatility surface; b) random forest is more competitive at short horizons (e.g., 1-day), for short-dated options (with less than 7 days to maturity), and on days with poor liquidity; c) both structural models outperform random forest in out-of-sample delta hedging; d) the Heston model's relative performance has deteriorated significantly after the 2008 financial crisis.

Does Idiosyncratic Volatility Proxy for a Missing Risk Factor? Evidence Using Portfolios as Test Assets
Gempesaw, David,Kassa, Haim,Zykaj, Blerina Bela
One of the main explanations for the idiosyncratic volatility (IVOL) puzzle (i.e., the negative relation between lagged IVOL and returns) is a missing risk factor. We show analytically that if IVOL proxies for a missing risk factor, then the negative relation between IVOL and returns should persist when using diversified portfolios as test assets. However, we do not find a significantly negative empirical relation using randomly selected portfolios and characteristic-based portfolios (exchange-traded funds and Fama-French portfolios formed on size, book-to-market, and industry) as test assets. Our results suggest that the IVOL puzzle is not due to a missing risk factor.

Dynamical Internal Cost of Capital Driven by Cash Flow Growth
Solo, David,Sornette, Didier ,Ulmann, Florian
Based on the insight that risk exposure as quantified in the consumption based asset pricing model (CCAPM) is linearly proportional to the cash flow growth rate, we introduce a discounted cash flow model with a time-varying expected return structure matching the implicitly assumed risk exposure at each future point in time in the valuation model, i.e. the assumed cash flow growth rate process. This reduces the range of reasonable valuations outcomes to useful levels, given that the linearly proportional term structures of potential cash flow growth rates and equity risk premia are complementary, offsetting variables in a discounted cash flow pricing model. In the same manner we elaborate a time-varying internal cost of capital (ICC) model that reflects the implied risk exposure at each future point in time and thus has a clear interpretation as an expected return process. This time-varying ICC model is superior to the constant ICC model in a Fama-MacBeth regression setting to predict future realised returns. And using the expected return of the time varying ICC model as control in a Fama-MacBeth regression of the profitability, the investment and the value factor, both the profitability and the value factor become insignificant in explaining future realised returns. The superiority and economic significance of the time-varying ICC model is further confirmed in a trading strategy with yearly rebalancing.

FinTech Lending and Cashless Payments
Ghosh, Pulak,Vallee, Boris,Zeng, Yao
This study provides a new perspective to understand the rise and future potential of FinTech lending by linking it to the informational role of cashless payments. We uncover both theoretically and empirically a synergy between FinTech lending and cashless payments. FinTech lenders screen borrowers more efficiently when borrowers use more cashless payments that produce transferrable and verifiable information. Because borrowers expect lenders to rely on such payment information to screen them, a strategic consideration for a borrower to stand out of other borrowers then pushes more borrowers to adopt cashless payments. Using novel loan-level data from a large Indian FinTech lender who focuses on small-business lending, we find that a larger use of verifiable cashless payments (relative to cash) predicts a higher chance of loan approval, a lower interest rate, and lower default conditional on the interest rate obtained. These relationships are more pronounced for higher-quality firms. The uncovered synergy provides a plausible explanation for the joint rise of FinTech lending and cashless payments, and suggests an alternative banking model without a balance sheet or traditional banking relationships. Our findings also provide new policy implications on data sharing and open banking.

Financial Interlocks and the Cost of Debt in a Setting with Concentrated Family Ownership
Volpentesta, Valeria,André, Paul,Morricone, Serena
We investigate the role of board directors from financial institutions (financial interlocks) on the relationship between ownership structure and the cost of debt. In Italy, ownership is largely concentrated often in families, and financial institutions are the primary source of funding for firms. These characteristics offer a context to examine debt-equity agency conflicts and whether having direct internal monitoring channels such as financial interlocks reduces a firm’s cost of debt. We show that while concentrated ownership has an increasing effect on the cost of debt, financial interlocks moderate this relationship. Further, we find that financial interlocks act as an even more important tool in mitigating the agency cost of debt in cases of family ownership. Our results are robust to a set of firm-specific characteristics and support the idea that financial interlocks provide firms with a monitoring device that could resolve some of the debt-equity agency conflicts.

Fund Share Gains Lead to Borrower Pains: Investor Competition and the Cost of Capital
Chen, Huaizhi
I argue that delegated investors form oligopsonies in the short-term securities market, and their competition affects borrowing costs. In particular, I document that the enactment of Money Market Mutual Fund reforms on October 2016 prompted many delegated asset managers to exit the market for short-term securities and increased the concentration of remaining investors, especially in the tax-exempt categories. Subsequently, tax-exempt funds obtained after-tax portfolio yields that were 27 basis points higher than comparable taxable funds. Consistent with pricing power, the largest fund families received higher promised returns (up to 10 basis points) than smaller families on the same class of assets. Additionally, I show that the remarketers set higher payment rates for short-term securities directly held by their affiliated funds. These results highlight the trade-off in enacting macro-prudential policies and encouraging capital market efficiency.

Future Earnings Information in Business Text
Green, Jeffrey,Green, Jeremiah,Kartapanis, Antonis
We show that measures of business text sentiment are highly affected by transitory events. These transitory events lead to a strong positive association between sentiment and contemporaneous earnings. However, the association between sentiment and future earnings is insignificant. We develop a quantification of business text that is less affected by transitory events and is therefore better suited for prediction. Applied to 10-K filings, our proposed measure is strongly associated with both contemporaneous and future earnings. Further, applied to earnings announcements, our measure is strongly associated with future returns. Other tests verify and confirm the value of our measurement approach.

Gender and Firm Performance around the World: The Roles of Finance, Technology, and Labor
Allison, Lee,Liu, Yu,Murtinu, Samuele,Wei, Zuobao
Using the World Bank Enterprise Survey (WBES) data from 2006-2017 on 130,000 firms in 130 countries across the globe, we document that women-led firms tend to underperform men-led firms. The main contribution of this work is to shed light on three mechanisms that help explain the underperformance: finance, technology, and labor. First, women-led firms are investing less in fixed assets and obtaining less credit from banks. Second, women-led firms are less likely to use information technology to manage their businesses. Third, women-led firms tend to employ more skilled and educated workers, and are more likely to provide workers with permanent contracts, hence incurring higher labor costs. Interestingly, in our data, women top managers do not perceive themselves facing more business obstacles than their male counterparts do.

History, Shocks and Drifts: A New Approach to Portfolio Formation
Kritzman, Mark,Turkington, David
Investors intuitively view future possibilities as a combination of historical outcomes, shocks that occur suddenly, and drifts that unfold gradually over several years. The authors show how to build portfolios based on such a view of the future. Their key innovation is to create a mixed-frequency return sample that properly balances short-term and long-term returns, and to form portfolios by considering all the returns of the sample instead of a statistical summary of them.

How Does Internet Finance Influence the Monetary Policy? Evidence from China
Rathnayake, Dilesha,Dan, Jiang,Louembe, Pierre Axel,Yvanna, Otek Ntsama Ursule
Chinese banks have gradually expanded their financial services into overseas financial services and financial trade transactions. The financial services system is becoming more and more humanized and intelligent with the global economy’s rapid development and progress. It improves the quality of banks’ financial services and plays a vital role in its financial system construction and financial product innovation. As an internal driving force for the development of the financial industry, financial innovation has a vast and extensive impact on the economy. Because of the importance of monetary policy on national macroeconomic regulation and control, it is of great practical significance to study the impact of financial innovation on monetary policy effectiveness. This paper has conducted an in-depth analysis of the core concepts of internet finance, and suggestions and policy implications are given to improve China’s monetary policy’s effectiveness.

Learning Equilibrium Mean-Variance Strategy
Dai, Min,Yuchao, Dong,Jia, Yanwei
We study a dynamic mean-variance portfolio optimization problem under the reinforcement learning framework, where an entropy regularizer is introduced to induce exploration. Due to the time-inconsistency involved in a mean-variance criterion, we aim to learn an equilibrium strategy. Under an incomplete market setting, we obtain a semi-analytical, exploratory, equilibrium mean-variance strategy that turns out to follow a Gaussian distribution. We then focus on a Gaussian mean return model and propose an algorithm to find the equilibrium strategy using the reinforcement learning technique. Thanks to a thoroughly designed policy iteration procedure in our algorithm, we can prove our algorithm's convergence under mild conditions, despite that dynamic programming principle and the usual policy improvement theorem fail to hold for an equilibrium solution. Numerical experiments are given to demonstrate our algorithm.

Letting Companies Choose between Board Models: An Empirical Analysis of Country Variations
Gelter, Martin,Siems, Mathias
This paper has a dual aim: it aims to contribute to the substance of comparative corporate law and it aims to advance the methodology of comparative legal research. In substantive terms, the paper addresses the key question about the design of a suitable board structure. It notes that today many countries not only allow modifications of the default structure, but provide two separate legal templates by giving firms a choice between a one-tier and a two-tier board model. Yet, information on the actual choices made by companies is rare. This paper aims to fill this gap. It presents original data about the choice of board models from 14 European jurisdictions, analyzing variations of popularity of these models at the country level. For this purpose, the paper applies the techniques of “correspondence analysis” and “qualitative comparative analysis”, which have been developed by other academic disciplines but have so far been rarely employed in comparative legal scholarship. One of the main advantages of these techniques is that they do not depend on a large number of observations as is the case for econometric methods. They are also intuitive to use for legal scholars as they are not simply based on particular numerical scores (such as significant levels) but ask researchers to use their qualitative skills and knowledge in research design and evaluation. In conclusion, the new data and analyses show that there are profound country differences in the preferred choice for one of the board models and that both path dependence andlegal differences can help to explain those variations.

Managing Climate Change Risk: The Policy Options for Central Banks
Ozili, Peterson K
This article discusses some policy options that central banks may find useful in dealing with climate change risk in the financial sector. The effect of climate change on the financial sector are indirect but severe when they occur. Central banks play an important role in regulating the financial sector and in managing its inherent risks, yet there are no studies that suggest policy solutions to help central banks and other financial sector regulators deal with the risk that climate change pose to the financial sector. Five policy options are proposed in the paper, which includes: imposing a climate change capital surcharge; impose a fixed-rate risk capital - based on Tier 2 capital; a reduction in lending to industries whose activities destroy the environment and climate; creating a climate bank; and, requiring financial institutions to relocate their important assets to areas less prone to climate change events. Several policy experiments are needed to identify the best policy option that works best for each country while taking into account the unique financial sector, financial system and climate change history of each country.

Mental Time Travel and the Valuation of Financial Investments
Blake, David P.,Pickles, John
PurposeTo portray the valuation of financial investments as mental time travel. Design/methodology/approachIn a series of thought investments, $1 invested in an investment fund is mentally projected forward in time and then discounted back to the present â€" with no objective time passing. The thought investments feature symmetric valuation (in which discount rates exactly match projection rates) and asymmetric valuation (in which discount rates and projection rates happen to differ). They show how asymmetric valuation can result in differences between the current personal value and market value of an investment and, by way of real-world illustration, between a closed-end investment fund’s net asset value and its market value. We explore possible reasons for asymmetric valuation.FindingsThought investments illustrating mental time travel can be used to help understand both financial investment valuation generally and, more specifically, established explanations of the closed-end investment fund puzzle. We show how different expectations, different perceptions of time and risk and different risk and time preferences might help determine value.OriginalityThere are vast literatures on prospection, discounting and future-orientated or intertemporal decision-making. Our innovation is to illustrate how these mental activities might combine to facilitate financial investment valuation. In particular, we show that a low personal discount rate could be a consequence of a shortened perception of future time and vice versa.

On the Market-Consistent Valuation of Participating Life Insurance Heterogeneous Contracts under Longevity Risk
Bacinello, Anna Rita,Chen, An,Sehner, Thorsten,Millossovich, Pietro
The purpose of this paper is to conduct a market-consistent valuation of life insurance participating liabilities sold to a population of partially heterogeneous customers under the joint impact of biometric and financial risk. In particular, the heterogeneity between groups of policyholders stems from their offered minimum interest rate guarantees and contract maturities. We analyze the effects of these features on the company's insolvency while embracing the insurer's goal to achieve the same expected return for different cohorts of policyholders. Within our extensive numerical analyses, we determine the fair participation rates and other key figures, and discuss the implications for the stakeholders, taking account of various degrees of conservativeness of the insurer when pricing the contracts.

Pressured to Perform: Evidence from a Quasi-Experiment of Initial CEO Contract Length and M&As
Chen, Guoli,Huang, Ronghong,Mei, Shunji,Tan, Kelvin Jui Keng
This paper examines whether CEOs with shorter initial contract lengths suffer from greater pressure and consequently engage in more visible efforts via mergers and acquisitions (M&As). By using CEO initial fixed-term contracts and exploiting U.K. corporate governance reform as an exogenous shock, we find that (1) CEOs with shorter initial contract lengths engage in more (and salient) M&As with relatively weaker market reactions; (2) the likelihood of contract renewal is higher among CEOs who engage in more visible efforts, while long-term performance still matters the most; and (3) firms with better corporate governance are more vigilant to visible efforts.

Profit-Tax Relationship, Business Group Affiliation, and External Monitoring in China
Lin, Kenny,Shi, Shanshan,Tang, Feng
This study examines whether business group affiliation weakens the sensitivity of income tax expense to pretax income, while external monitoring mechanisms mitigate the effect of group affiliation. We find that this sensitivity is weaker for Chinese listed firms affiliated with a top 500 business group than for unaffiliated firms. Economically, our coefficient estimate implies that group affiliation weakens tax sensitivity to income by 5.2% in relative terms. However, we find that tax sensitivity improved in the post-2008 period and with the presence of strong monitoring mechanisms by means of tax enforcement, analyst scrutiny, and long-term institutional shareholding. To the extent that unexplained variation in current tax expense at a given income level is indicative of aggressive tax behavior, our results suggest that effective external monitoring can mitigate this behavior in group-affiliated firms.

Real and Private-Value Assets
Goetzmann, William N.,Spaenjers, Christophe,Van Nieuwerburgh, Stijn
Real and private-value assetsâ€"defined here as the sum of real estate, infrastructure, collectibles, and non-corporate business equityâ€"is an investment class worth an estimated $85 trillion in the U.S. alone. Furthermore, private values can affect pricing in many other financial markets, such as that for sustainable investments. This paper introduces the research on real assets and private values that can be found in this special issue. It also reviews recent advancesâ€"and suggests new research directionsâ€"on a number of topics in the real assets space that we believe to be particularly important and exciting.

Reducing Climate Transition Risk in Central Banks’ Asset Purchasing Programs
Bressan, Giacomo,Monasterolo, Irene,Battiston, Stefano
In this paper we analyze whether and how a central bank can pursue the objective to lower its exposure to climate-related financial risks in its asset purchase programs while meeting the criteria that define the eligible universe of assets, including market neutrality. Despite focusing on the analysis of European Central Bank (ECB)’s asset purchase program and its exposure to climate transition risk, our approach and results can be applied to other central banks. We first prove analytically that under a strict market neutrality principle, the ECB’s corporate bonds’ portfolio is completely determined and climate transition risk cannot be reduced. We then show that under a weaker market neutrality principle, it is possible to construct a portfolio with lower exposure to climate transition risk than the current one. We provide a simple algorithm to produce examples of such portfolios. Our results contribute to support central banks in the assessment of their exposure to climate-related financial risks, and in the introduction of climate change considerations in their assets purchase programs.

Return on Investment on AI : The Case of Capital Requirement
Fraisse, Henri,LAPORTE, Matthias
Taking advantage of granular data we measure the change in bank capital requirement resulting from the implementation of AI techniques to predict corporate defaults. For each of the largest banks operating in France we design an algorithm to build pseudo-internal models of credit risk management for a range of methodologies extensively used in AI (random forest, gradient boosting, ridge regression, deep learning). We compare these models to the traditional model usually in place that basically relies on a combination of logistic regression and expert judgement. The comparison is made along two sets of criterias capturing : the ability to pass compliance tests used by the regulators during onsite missions of model validation (i), and the induced changes in capital requirement (ii). The different models show noticeable differences in their ability to pass the regulatory tests and to lead to a reduction in capital requirement. While displaying a similar ability than the traditional model to pass compliance tests, neural networks provide the strongest incentive for banks to apply AI models for their internal model of credit risk of corporate businesses as they lead in some cases to sizeable reduction in capital requirement.

Shock and Spillover Effects of Global Commodity Markets on Some African Equity Markets
Boakye, Ernest
The influx of financial institutions into commodity markets, also known as the financialization of commodity markets, is a global phenomenon. This paper investigates the shock and spillover effects between commodity markets and some African equity markets using VAR-GARCH and DCC-GARCH approaches. The results show no equity return predictability in the African equity markets, supporting the main ideas of the efficient-market hypothesis (EMH). However, we find statistically significant risk and shock spillovers from the international commodity markets on African equity markets as well as spillover effects from the global implied volatility indicators. Furthermore, we find that the risk effects are time-varying and that they become stronger when the market risks increase, particularly during and after the global financial crisis (GFC). In sum, our findings show that the intensive financialization of commodity markets has had a clear role in the spreading of commodity market risks to African equity markets.

Size Anomalies in U.S. Bank Stock Returns and Banking Reforms
Richardson, Gary,Yang, Brian
Using unique data on over-the-counter bank stock prices and balance sheet information we explore bank funding cost differentials using the risk-adjusted return gap between the largest and the smallest depository institutions. We find that the largest commercial bank stocks, ranked by market value or gross deposits, have significant lower risk-adjusted annual returns than do small sized bank stocks even after controlling for standard risk factors including size. This return difference is one of the first instances of preferential treatment for large banks and can be attributed to the Banking Act of 1935 which authorized the FDIC to act as the liquidator for all insured banks, and to choose which bank would be resolved by purchase and assumption and which by liquidation. Failures of larger institutions tended to be resolved by purchase and assumption, which is preferred because it preserves the value of the going concern, while failures of smaller institutions tended to be resolved by payoff and liquidation. When examined during the period of 1926 to 1939, when there are no such guarantees, we do not find any risk-adjusted returns differences between different sizes of banks.

Sovereign Risk, Credit Shocks and R&D
Grandi, Pietro,Belin, Jean,Darriet, Elisa,Guille, Marianne
We study how private R&D investment in France was affected by the tightening of credit conditions during the European Sovereign Debt Crisis. Using detailed R&D information on more than 25000 French companies, we show that financially constrained firms were relatively more likely to scale back their R&D activities following the sovereign debt crisis. We then focus on bank-firm linkages and exploit variation in the sovereign risk exposure of firms’ main bank during the sovereign debt crisis as an exogenous credit supply shock. Results indicate that firms related to banks with larger exposures to risky sovereign debt decreased R&D expenditure by more relative to other firms following the crisis. Our findings indicate that credit supply shocks have significant impact on firms’ R&D activities, and highlight an important transmission channel of sovereign risk to firm innovation and productivity.

The Effects of Local Government Financial Distress: Evidence from Toxic Loans
Sauvagnat, Julien,Vallee, Boris
We examine the response from both local governments and their voters to a sudden increase in public debt burden. We exploit plausibly exogenous variation in the ex post cost of toxic loans, a notorious financial innovation adopted by a large number of local governments. A large increase in the debt burden of a local government results in a significant reduction in its investments, but leaves expenses and taxes mostly unchanged. This effect is dampened for local governments that are more politically contested. An increase in public debt reduces the likelihood of re-election for incumbent mayor and its political party. Overall, these findings support the existence of a public debt overhang effect, which binds differently depending on the political context as contested mayors strive to maintain investments.

The Relationship Between Changes in Analyst Consensus Earnings Forecasts and Subsequent Share Returns on the Johannesburg Stock Exchange
Muller, Chris,Ward, Mike
Sell-side company analysts are most likely to be closest to a company’s financial health, will be privy to new information, and run models that process new information into meaningful expected changes to future earnings per share. Importantly, data vendors collate analyst’s individual Eps forecasts and publish consensus median Eps forecasts for the next three financial year-ends. A change in a median consensus forecast should be followed directly by a commensurate change in share price. We run a style analysis over 16 years, ranking quintile portfolios by the year-on-year change to Eps forecasts three months after portfolio formation. We find strong and consistent evidence that subsequent return is highly positively correlated with Eps upgrade. We vary both look-back and look-forward periods from one month to 12 months, confirming that three months forward, and 12 months backward, are optimal settings to maximise alpha. The effect is concentrated in the outer quintiles, with significant alpha generated when we move to decile portfolios.

The Tax Cut and Jobs Act (2017) as a Driver of Pension Derisking: A Comprehensive Examination
Anantharaman, Divya,Kamath, Saipriya,Li, Shengnan
Corporate defined-benefit (DB) pension sponsors in the US are increasingly on a path of “derisking” â€" by moving pension assets away from equities and towards fixed-income securities that better match the obligations, or by transferring obligations off their balance sheets entirely, via settlements with insurance companies or lump-sum payouts to beneficiaries. In this study, we examine whether the Tax Cut and Jobs Act of 2017 (“TCJA”) served as a driver of pension derisking. Examining behavior in the window between the TCJA’s announcement and its lower tax rate going into effect, we document that sponsors with stronger incentives to derisk their pensions tend to contribute more into their plans in that window, while deductions can still be taken at the higher tax rate â€" specifically, sponsors expecting large and uncertain contribution requirements for pensions in the future, facing high regulatory costs to maintaining plans, and with competing demands on cash flows. Examining behavior after the TCJA goes into effect, we document that the firms with the largest TCJA-triggered contributions also engage in more derisking subsequently, both by shifting asset allocations and by transferring obligations to other parties. In sum, our findings point to the TCJA having acted as a trigger for what could be a fundamental reorganization of the DB pension landscape in the US.

Venture Capital and Startup Innovation --Big Data Analysis of Patent Data--
Washimi, Kazuaki
With the declining birthrate and ageing population and a decline in the working age population in Japan, Japanese firms face the need to strengthen innovation including the digital domain. Expectations are particularly high for startups as they play a vital role in creating innovative technology. In recent years, there have been a number of initiatives such as expediting patent examinations and introducing an open innovation tax incentive in Japan. It is expected that venture capital (VC) funds will play a pivotal role in providing financing for growth so that startups can continue research and development. On the other hand, due in part to data constraints, there has been limited research on startup innovation on a comprehensive scale and virtually no earlier literature on the impact of VC investments on innovation by portfolio companies in Japan. This paper summarizes those two issues with a focus on the number of patent applications as a proxy for innovation, and it also discusses challenges that lie ahead. First, taking a look at patent applications by startups, around 40 percent of startups have applied for a patent—albeit with significant variation across firms—which appears a much higher proportion than existing firms. An estimate of the impact of VC investments on innovation suggests that in about 60 percent of cases, the number of patent applications by portfolio companies significantly increased compared to a control group. While care should be taken in interpreting those studies as the results vary from firm to firm, these successful cases reflect the possibility that financing and management support including intellectual property management from VC funds could have contributed to an increase in patent applications. Challenges ahead include: (1) expanding investments in VC funds by institutional investors; (2) increasing opportunities for startups to go public in a way that encourages sustainable growth; and (3) establishing intellectual property strategies while maintaining and developing professional human resources in relevant areas.