Research articles for the 2021-03-16

Annual Report Readability and the Cost of Equity Capital
Rjiba, Hatem,Saadi, Samir,Boubaker, Sabri,Ding, Xiaoya (Sara)
Using a large panel of U.S. public firms, we examine the relation between annual report readability and cost of equity capital. We hypothesize that complex textual reporting deters investors’ ability to process and interpret annual reports, leading to higher information risk, and thus higher cost of equity financing. Consistent with our prediction, we find that greater textual complexity is associated with higher cost of equity capital. Our results are robust to a battery of sensitivity checks, including use of multiple estimation methods, alternative proxies of annual report readability and cost of equity capital measures, and potential endogeneity concerns. In addition, we hypothesize and test whether the nature of the relation between readability and cost of capital depends on the tone of 10-K filings. Our results show that the effect of annual report complexity on cost of equity is greater when disclosure tone is more negative or more ambiguous. We also find that the effect of annual report readability on cost of equity capital depends on the degree of stock market competition, level of institutional investors’ ownership, and analyst coverage.

Asymptotics for rough stochastic volatility models
Martin Forde,Hongzhong Zhang

Using the large deviation principle (LDP) for a re-scaled fractional Brownian motion $B^H_t$ where the rate function is defined via the reproducing kernel Hilbert space, we compute small-time asymptotics for a correlated fractional stochastic volatility model of the form $dS_t=S_t\sigma(Y_t) (\bar{\rho} dW_t +\rho dB_t), \,dY_t=dB^H_t$ where $\sigma$ is $\alpha$-H\"{o}lder continuous for some $\alpha\in(0,1]$; in particular, we show that $t^{H-\frac{1}{2}} \log S_t $ satisfies the LDP as $t\to0$ and the model has a well-defined implied volatility smile as $t \to 0$, when the log-moneyness $k(t)=x t^{\frac{1}{2}-H}$. Thus the smile steepens to infinity or flattens to zero depending on whether $H\in(0,\frac{1}{2})$ or $H\in(\frac{1}{2},1)$. We also compute large-time asymptotics for a fractional local-stochastic volatility model of the form: $dS_t= S_t^{\beta} |Y_t|^p dW_t,dY_t=dB^H_t$, and we generalize two identities in Matsumoto&Yor05 to show that $\frac{1}{t^{2H}}\log \frac{1}{t}\int_0^t e^{2 B^H_s} ds$ and $\frac{1}{t^{2H}}(\log \int_0^t e^{2(\mu s+B^H_s)} ds-2 \mu t)$ converge in law to $ 2\mathrm{max}_{0 \le s \le 1} B^H_{s}$ and $2B_1$ respectively for $H \in (0,\frac{1}{2})$ and $\mu>0$ as $t \to \infty$.

COVID-19 Information Consumption and Stock Market Return
Muktadir-al-Mukit, Dewan
This paper examines the impact of COVID-19 information attention on stock market return. We use Google search volume index to proxy investor information attention in respect to case, death, lockdown and vaccine. We uncover that information attention towards lockdown and vaccine positively affects investor sentiment, reflected through increase in stock market return. By contrast, we do not find significant impact of case information attention on stock market return. However, we uncover that COVID-19 death information attention is negatively associated with stork market return for only initial 90 days trading period. Our results are consistent to a battery of robustness tests. Our study contributes to the understanding of the relationship between investor information attention and asset pricing during economic uncertainty and particularly, during pandemic state.

Can Machine Learning Help to Select Portfolios of Mutual Funds?
DeMiguel, Victor,Gil-Bazo, Javier,Nogales, Francisco J.,A. P. Santos, Andre
Identifying outperforming mutual funds ex-ante is a notoriously difficult task. We use machine learning methods to exploit the predictive ability of a large set of mutual fund characteristics that are readily available to investors. Using data on US equity funds in the 1980-2018 period, the methods allow us to construct portfolios of funds that earn positive and significant out-of-sample risk-adjusted after-fee returns as high as 4.2% per year. We further show that such outstanding performance is the joint outcome of both exploiting the information contained in multiple fund characteristics and allowing for flexibility in the relationship between predictors and fund performance. Our results confirm that even retail investors can benefit from investing in actively managed funds. However, we also find that the performance of all our portfolios has declined over time, consistent with increased competition in the asset market and diseconomies of scale at the industry level.

Central Bank Digital Currency and Balance Sheet Policy
Fraschini, Martina,Somoza, Luciano,Terracciano, Tammaro
This paper studies a stylized economy in which the central bank can hold either treasuries or risky securities against central bank digital currency (CBDC) deposits. The key mechanism driving the results is the reduction in bank deposits that follows the introduction of a CBDC and its impact on the banking sector. With CBDC funds invested in treasuries, the central bank channels funds back to the banking sector via open market operations and the introduction of a CBDC is neutral, consistently with the equivalence theorem of Brunnermeier and Niepelt (2019). However, it is not neutral when accounting for liquidity requirements, quantitative easing, or for CBDC deposits held against risky securities. We reach two main conclusions. First, current monetary policy regimes do matter for CBDC equilibrium effects. Second, there is a trade-off between bank lending to the economy and taxes, as holding risky assets against CBDC deposits leads to lower expected taxes and lower bank lending.

Chinese Outward Foreign Direct Investment in Belt and Road Countries: Trends, Characteristics and Policies
Chang, Le,Cheong, Kee-Cheok
Chinese outward foreign direct investment (OFDI) has attracted more attention in recent years, especially after the Chinese government proclaimed the Belt and Road Initiative (BRI) in 2013. The BRI countries play a key role in receiving Chinese OFDI. This paper analyzes the characteristics and trends of Chinese investment in BRI countries from the geographical and industrial perspectives by using both micro- and macro-level data. Meanwhile, it explores the Chinese government policy that promotes investment in BRI countries. This shows the way of Chinese investment strategy, especially in terms of country chosen and industry chosen. The analysis points out the reasons of Chinese investment, which is natural resource-seeking and market-­seeking. Meanwhile, Chinese government policy affects the decision of Chinese enterprises by using economic incentive.

Complete and competitive financial markets in a complex world
Gianluca Cassese

We investigate the possibility of completing financial markets in a model with no exogenous probability measure and market imperfections. A necessary and sufficient condition is obtained for such extension to be possible.

Credit Refinancing and Tax Avoidance
Alexander, Anna,Pisa, Magdalena
This paper examines the disciplining effects of credit markets on corporate tax avoidance strategies. We show that, during adverse credit market conditions, firms with refinancing needs prefer to forgo the after-tax cash flow benefits of tax avoidance to regain the access to the traditionally risk-averse credit markets. Our results show that firms increase their effective tax rate by 2 percentage points when facing refinancing constraints. This effect is more pronounced for firms with lower asset tangibility and higher default probability. Adverse credit market conditions together with refinancing needs prompt firms to become more conservative in their future tax avoidance strategy for up to three years. Moreover, we show that firms engage in less tax deferral strategies, while leaving their leverage and debt shield unchanged. Overall, these findings are consistent with credit markets putting pressure on tax avoiding firms.

Cross Currency Valuation and Hedging in the Multiple Curve Framework
Alessandro Gnoatto,Nicole Seiffert

We generalize the results of Bielecki and Rutkowski (2015) on funding and collateralization to a multi-currency framework and link their results with those of Piterbarg (2012), Moreni and Pallavicini (2017), and Fujii et al. (2010b).

In doing this, we provide a complete study of absence of arbitrage in a multi-currency market where, in each single monetary area, multiple interest rates coexist. We first characterize absence of arbitrage in the case without collateral.

After that we study collateralization schemes in a very general situation: the cash flows of the contingent claim and those associated to the collateral agreement can be specified in any currency. We study both segregation and rehypothecation and allow for cash and risky collateral in arbitrary currency specifications. Absence of arbitrage and pricing in the presence of collateral are discussed under all possible combinations of conventions.

Our work provides a reference for the analysis of wealth dynamics, we also provide valuation formulas that are a useful foundation for cross-currency curve construction techniques. Our framework provides also a solid foundation for the construction of multi-currency simulation models for the generation of exposure profiles in the context of xVA calculations.

Decentralising the United Kingdom: the Northern Powerhouse strategy and urban ownership links between firms since 2010
Natalia Zdanowska,Robin Morphet

This paper explores a decentralisation initiative in the United Kingdom - the Northern Powerhouse strategy (NPS) - in terms of its main goal: strengthening connectivity between Northern cities of England. It focuses on economic interactions of these cities, defined by ownership linkages between firms, since the NPS's launch in 2010. The analysis reveals a relatively weak increase in the intensity of economic regional patterns in the North, in spite of a shift away from NPS cities' traditional manufacturing base. These results suggest potential directions for policy-makers in terms of the future implementation of the NPS.

Determinants of Earnout as Acquisition Payment Currency and Bidder's Value Gains
Barbopoulos, Leonidas G.,Sudarsanam, Puliyur
We examine the wealth effects of a comprehensive sample of UK bidders offering contingent payment, or earnout, as consideration for their acquisitions. We show that bidders using earnout generate signifi- cantly higher announcement and post-acquisition value gains than bidders using non-earnout currencies (such as cash, stock exchange, or mixed payments). We construct a logistic model to predict when it is optimal for a bidder to offer earnout. We show that bidders offering earnout optimally enjoy significantly higher announcement and post-acquisition gains than bidders offering non-earnout currencies, consis- tent with our model of the choice of the optimal method of payment. Overall, we provide robust evidence that earnout is an effective payment mechanism to mitigate valuation risk to acquirers, and also enhances acquirer value during the announcement and post-acquisition periods. Our paper contributes to the broader literature on how corporate acquirers use payment currency to manage information asym- metry and the attendant valuation risk.

Digesting Three-Factor Model by XGBoost and SHAP
Huang, Weige
This paper innovatively digests three-factor model by exploring the average impacts of factors on portfolio returns and how factors interact with each other. To do this, we use SHapley Additive exPlanations method (SHAP) to interpret the results obtained by XGBoost. We find that the factors have different impacts on portfolio returns and interact with each other in different (sometimes surprising) ways. We also find that the average impacts of factors on portfolio returns are similar before and after the publication of the three-factor model and the 2008 financial crisis but the interaction between factors vary across times.

Dissemination, Publication, and Impact of Finance Research: When Novelty Meets Conventionality
Dai, Rui,Donohue, Lawrence,Drechsler, Qingyi (Freda) Song,Jiang, Wei
Using numeric and textual data extracted from over 50,000 finance articles posted in the Social Science Research Network (SSRN) between 2001 and 2019, this study examines the relationship between measured qualities and a paper's eventual outlet as well as its impact. Based on semantic characteristics uncovered with newly developed machine learning tools, we find that conventionality (semantic similarity with existent research) helps boost readership and publication prospects, after controlling for various article and author characteristics including reputation and research resources of the affiliated institution and author network. Novelty through investigating emerging topics and adopting fresh databases boosts the attention from a broader audience and also the probability of top tier publication, but novelty from introducing atypical ideas from non-finance focused fields or inter-field research does not achieve the same goals.

Do Corporations Learn from Mispricing? Evidence from Takeovers and Corporate Performance
Adra, Samer,Barbopoulos, Leonidas G.
In this article we form the simple prediction that mispricing encourages traders to collect costly information that guides managerial decisions at corporate level. Our findings support this prediction based on evidence derived from both the US market for corporate control and the overall variation in aggregate corporate profits. The trading activity in response to the temporary mispricing of the merging companies provides useful information that leads to the design of high-synergy deals. Such synergies are reflected in an increase in the announcement period acquirer abnormal returns and are not reversed in the long-run. At the market-wide level, our results suggest that the growth in the overall stock trading volume in response to market mispricing is associated with high future corporate profit growth. Overall, after controlling for several economic and financial conditions, the temporary mispricing in a developed and generally efficient stock market stimulates informative trading, ultimately leading to value- and performance-enhancing corporate decisions.

Do Macroprudential Policies Affect Non-Bank Financial Intermediation?
Claessens, Stijn,Cornelli, Giulio,Gambacorta, Leonardo,Manaresi, Francesco,Shiina, Yasushi
We analyse how macroprudential policies (MaPs), largely applied to banks and to a lesser extent borrowers, affect non-bank financial intermediation (NBFI). Using data for 24 of the jurisdictions participating in the Financial Stability Board’s monitoring exercise over the period 2002â€"17, we study the effects of MaP episodes on bank assets and on those NBFI activities that may involve bank-like financial stability risks (the narrow measure of NBFI). We find that a net tightening of domestic MaPs increases these NBFI activities and decreases bank assets, raising the NBFI share in total financial assets. By contrast, a net tightening of MaPs in foreign jurisdictions leads to a reduction of the NBFI share â€" the effect of a drop in NBFI activities and an increase in domestic banking assets. Tightening and easing MaPs have largely symmetric effects on NBFI. We find that the effect of MaPs (both domestic and foreign) is economically and statistically significant for all those NBFI economic functions that may pose risks to financial stability.

Does Board Gender Diversity Matter? Evidence From Hostile Takeover Vulnerability
Chatjuthamard, Pattanaporn,Jiraporn, Pornsit,Lee, Sang Mook,Uyar, Ali,Kilic, Merve
Purpose â€" Theory suggests that the market for corporate control, which constitutes an important external governance mechanism, may substitute for internal governance. Consistent with this notion, using a novel measure of takeover vulnerability primarily based on state legislation, we investigate the effect of the takeover market on board characteristics with special emphasis on board gender diversity.Design/methodology/approach â€" We exploit a novel measure of takeover vulnerability based on state legislations. This novel measure is likely exogenous as the legislation were imposed from outside the firm. By using an exogenous measure, our analysis is less vulnerable to endogeneity and is thus more likely to show a causal effect.Findings â€" Our results show that a more active takeover market leads to lower board gender diversity. Specifically, a rise in takeover vulnerability by one standard deviation results in a decline in board gender diversity by 10.01%. Moreover, stronger takeover market susceptibility also brings about larger board size and less board independence, corroborating the substitution effect. Additional analysis confirms the results, including propensity score matching, generalized method of moments dynamic panel data analysis, and instrumental-variable analysis.Originality â€" Our study is the first to explore the effect of the takeover market on board gender diversity. Unlike most of the previous research in this area, which suffers from endogeneity, we use a novel measure of takeover vulnerability that is probably exogenous. Our results are thus much more likely to demonstrate causality.

Earnout Financing in the Financial Services Industry
Barbopoulos, Leonidas G.,Molyneux, Philip,Wilson, John O. S.
This paper explores the effects of earnout contracts used in US financial services M&A. We use propensity score matching (PSM) to address selection bias issues with regard to the endogeneity of the decision of financial institutions to use such contracts. We find that the use of earnout contracts leads to significantly higher acquirer abnormal returns (short- and long-run) compared to counterpart acquisitions (control deals) which do not use such contracts. The larger the size of the deferred (earnout) payment, as a fraction of the total transaction value, the higher the acquirers' gains in the short- and long-run. Both acquirer short- and long-run gains increase when the management team of the target institution is retained in the post-acquisition period.

Electricity intraday price modeling with marked Hawkes processes
Thomas Deschatre,Pierre Gruet

We consider a 2-dimensional marked Hawkes process with increasing baseline intensity in order to model prices on electricity intraday markets. This model allows to represent different empirical facts such as increasing market activity, random jump sizes but above all microstructure noise through the signature plot. This last feature is of particular importance for practitioners and has not yet been modeled on those particular markets. We provide analytic formulas for first and second moments and for the signature plot, extending the classic results of Bacry et al. (2013) in the context of Hawkes processes with random jump sizes and time dependent baseline intensity. The tractable model we propose is estimated on German data and seems to fit the data well. We also provide a result about the convergence of the price process to a Brownian motion with increasing volatility at macroscopic scales, highlighting the Samuelson effect.

Endogenous Option Pricing
Gamba, Andrea,Saretto, Alessio
We show that a dynamic model of investment and capital structure choices, where the firm faces real and financial frictions, can generate option prices and implied volatilities that are in line with those of the average optionable stock. As the balance between the fundamental economic forces that are responsible for the way options are priced is state-dependent, the model is also able to generate a wide cross-sectional dispersion in implied volatility surfaces that matches what we observe in the data.

Estimating Peer Effects in Corporate Innovation: Evidence from Compensation Peer Groups
Hsu, Yuan-Teng,Huang , Chia-Wei,Koedijk, Kees
This paper uses compensation peer groups to measure peer effects in corporate innovation. This approach provides a true peer group and better leader-follower link and thus can mitigate the reflection problem suggested by Manski (1993). We find that the average innovation activity of the compensation peers is a significant and first-order predictor for corporate innovation. Further analyses show that (1) the peer effect is stronger when peer companies experience higher innovation competition and are closer to the median peer company in the peer group, (2) the results are not likely to be attributed to the knowledge spillover mechanism but rather are more consistent with the peer pressure mechanism, and (3) the SEC’s 2006 executive compensation disclosure rules can generate the peer effects. Overall, the results suggest that corporate innovation decisions are responses to innovation activities and, to a lesser extent, the characteristics of the compensation peer groups.

Feature Learning for Stock Price Prediction Shows a Significant Role of Analyst Rating
Jaideep Singh,Matloob Khushi

To reject the Efficient Market Hypothesis a set of 5 technical indicators and 23 fundamental indicators was identified to establish the possibility of generating excess returns on the stock market. Leveraging these data points and various classification machine learning models, trading data of the 505 equities on the US S&P500 over the past 20 years was analysed to develop a classifier effective for our cause. From any given day, we were able to predict the direction of change in price by 1% up to 10 days in the future. The predictions had an overall accuracy of 83.62% with a precision of 85% for buy signals and a recall of 100% for sell signals. Moreover, we grouped equities by their sector and repeated the experiment to see if grouping similar assets together positively effected the results but concluded that it showed no significant improvements in the performance rejecting the idea of sector-based analysis. Also, using feature ranking we could identify an even smaller set of 6 indicators while maintaining similar accuracies as that from the original 28 features and also uncovered the importance of buy, hold and sell analyst ratings as they came out to be the top contributors in the model. Finally, to evaluate the effectiveness of the classifier in real-life situations, it was backtested on FAANG equities using a modest trading strategy where it generated high returns of above 60% over the term of the testing dataset. In conclusion, our proposed methodology with the combination of purposefully picked features shows an improvement over the previous studies, and our model predicts the direction of 1% price changes on the 10th day with high confidence and with enough buffer to even build a robotic trading system.

Financial Flexibility Robustness
Qi, Qian
I examine how the robustness of investment opportunities influence firm payout policy and cash holdings. By exploiting new measures, the perturbations of q, a novel counterintuitive yet reasonable fact emerge: low robustness of investment opportunities (high perturbations of q) is able to spur firm propensity to pay dividends, lower repurchase shares, and decrease the cash a firm holds simultaneously. Specifically, firms that are likely to hold fewer amounts of cash when the robustness of investment opportunities is low, which is distinct from the standard channel of uncertainty. These results are consistent with firms' liquidity management policies being significantly shaped by robustness concerns.

Foreign Direct Investment in Emerging Markets and Acquirers’ Value Gains
Barbopoulos, Leonidas G.,Marshall, Andrew P.,MacInnes, Cameron,McColgan, Patrick
[enter Abstract Body]We investigate the shareholder wealth effects of 306 foreign direct investment (FDI) announcements by UK firms in seventy-five emerging markets (EM). Our results show that acquirers enjoy highly significant gains during the announcement period of FDI. Perhaps surprisingly, the highest gains are accrued to acquirers investing in countries with high political risk and high corruption ratings. The type of asset acquired has also a significant effect on the gains of acquirers’ shareholders, with the highest gains accrued to acquirers of physical assets. Also, investments in physical assets in EM with a high corruption rating elicit the highest gains. We contend that UK firms following resource-seeking strategies in EM with a high corruption rating are facilitated access to resources on favorable terms and this is viewed positively by the market participants. Our results are robust to alternative model specifications and the endogenous choice to expand internationally.

Further Evidence on Calendar Anomalies
Hsu, Yuan-Teng,Koedijk, Kees,Liu, Hung-Chun,Wang, Jying-Nan
This study aims to investigate the day-of-the-week (DoW) effect of cross-market leveraged exchange-traded funds (LETFs) in the Taiwanese stock market. We find that Wednesday’s overnight returns are significantly positive for bull 2X LETFs tracking major stock indices of the Chinese market, whereas no such an effect is found for ETFs tracking local or other international stock markets. The “T+1” trading rule and a lagged Monday effect potentially explain this anomaly. Finally, simulation analysis of various simple trading rules further shows that there exist exploitable profit opportunities in cross-market bull 2X LETF markets.

Gender Differences in Stock Market Participation: Evidence From Chinese Households
Li, Ling,lee, shuyi,Luo, Deming
Using micro household survey data from China, this study finds that women are less likely to participate in the stock market than men. This gender pattern in market participation rates holds when we control for household features, characteristics of both spouses, and their interactions and relative decision-making power. We also show that the gender difference in stock market participation operates through investors’ behavioral factors, particularly their risk preference. Moreover, we confirm the influence of cultural gender norms among older households. The gender difference in stock market participation is reduced where women’s influence over the decision of stock investments is likely constrained by a male-biased social norm. The study’s findings suggest the crucial role of gender and gender-related cultural norms in shaping household financial decisions in the presence of gender inequality, such as in China. It extends our understanding of the interrelations between financial decisions and social and behavioral dimensions in a developing context.

Has Financial Inclusion Made the Financial Sector Riskier?
Ozili, Peterson K
This paper examines whether high levels of financial inclusion is associated with greater financial risk. The findings reveal that higher account ownership is associated with greater financial risk through high nonperforming loan and high cost inefficiency in the financial sector of developed countries, advanced countries and transition economies. Increased use of debit cards, credit cards and digital finance products reduced risk in the financial sector of advanced countries and developed countries but not for transition economies and developing countries. The findings also show that the combined use of digital finance products with increased formal account ownership improves financial sector efficiency in developing countries while the combined use of credit cards with increased formal account ownership reduces insolvency risk and improves financial sector efficiency in developing countries.

Hedging and Competition
Giambona, Erasmo,Kumar, Anil,Phillips, Gordon M.
We study how risk management through hedging impacts firms and competition among firms in the insurance industry. We show that firms that are likely to face costly external finance increase hedging after staggered state-level financial reform that reduces the costs of hedging. These firms have lower risk and higher market stability. Post hedging, product market competition is also impacted. Firms that increase hedging lower price and increase policy sales relative to unaffected companies. These firms increase their market share after they engage in hedging.

Is the Merger of Banks on the Path of Expected Yields?
Venkatesh, K.A ,Narasimhan, Pushkala
Government of India announced the merger of 10 Public sector banks into 4 Banks in the month of August 2019 in order to reduce the NPA’s as well as reducing the burden of capital infusion to comply Bessel norms. Further mergers of Public Sector banks led to the emergence of 12 bigger banks. This article examines whether this consolidation of banks is really on the path of expected yields by assuming efficiencies as a parameter using inverse DEA. The M & A in banking sector has been evergreen research topic in the global arena and that gives impetus to the current research on Indian Mergers. Generally, the global research studies on M&A focused on the positive impact and the outcomes tend to be the conflicting nature. The InvDEA is the model which supports to identify the necessary level of inputs and outputs for a given decision making unit (Bank) to reach its predefined efficiency. This model facilitates in identifying the outcomes of mergers in terms of efficiency though the objectives of mergers where defined in different perspective. The elements of cost and profit were considered as inputs and outputs in ascertaining the efficiency and that will reveal the true picture of attaining the expected yield of the merger in short-term.

Judicial Efficiency and Banks Credit Risk Exposure
Canzian, Giulia,Ferrara, Antonella
We exploit the outset of a regulation seeking to improve judicial efficiency through the rearrangement of courts’ geography in Italy to provide causal evidence on the relationship between judiciary structural reforms and banks financial stability. To this end, we apply a difference-in-differences approach on a dataset on annual proceedings handled by each court over the period 2010-2017, complemented by banks balance sheet information. Our findings yield a negative effect of the reform on both judicial efficiency and Non-Performing Loans ratio. Furthermore, we identify heterogeneous effects based on the existing capacity of the courts to dispose of pending proceedings and geographical location. Digging deeper into this mechanism, we set up a causal mediation analysis to prove that the judicial system affects banks credit risk exposure both indirectly (through judicial efficiency) and directly, thereby influencing borrowers who react to the perceived enforcement.

Legal Systems and Gains from Cross-Border Acquisitions
Barbopoulos, Leonidas G.,Paudyal, Krishna,Pescetto, Gioia
While cross-border-acquisitions (CBA) constitute a significant and expanding proportion of the total mergers and acquisitions transactions, their benefits and costs to the acquiring firm's shareholders are not fully understood. The documented evidence that a country's legal environment and level of investor protection affect firm's value suggests that these same factors should also impact on the profitability of CBA. The paper con- tributes to the literature by examining the implications of the legal tradition of the target's country of domicile on bidders' gains, using a sample of UK acquiring firms. The findings, which are controlled for several factors that are known to affect acquirers' gains, show that the difference in the legal tradition of the target's nation plays a significant role in influencing the gains from CBA of UK acquirers. They also show that during both the announcement period and in the long-run acquiring firms of targets based in civil-law countries out-perform acquirers of targets based in common-law countries. In addition, acquiring a firm in markets that have higher restrictions on capital mobility, or stricter capital controls, can add more value to shareholders' wealth. Finally, the legal tradition of the target's nation interacts with several deal- and firm-specific factors in shaping the gains to acquiring firms.

Liquidity and Information Asymmetry Considerations in Corporate Takeovers
Adra, Samer,Barbopoulos, Leonidas G.
We examine how stock market liquidity and information asymmetry considerations influence the wealth effects of Mergers and Acquisitions (M&As). We present a simple model predicting that M&As of listed targets that have relatively illiquid stocks are profitable for acquirers due to (a) the weak bargaining power of the targets’ shareholders, and (b) the limited information asymmetry concerns when evaluating takeover synergies. Our results show that cash-financed M&As of listed targets that have relatively illiquid stocks are associated with an increase in acquirer risk-adjusted returns. These gains are equivalent to those realized from comparable private target M&As. When engaging in stock-financed listed-target M&As, acquirers with liquid stocks enjoy significant gains when the targets have relatively illiquid stocks. This result holds especially when the deal is announced during periods of deterioration in the overall stock market liquidity. Lastly, we find that liquidity considerations affect the acquirer’s choice of the target firm’s listing status, as well as the M&A method of payment.

Local Banks and the Effects of Oil Price Shocks
Wang, Teng
In this paper, I study the effects of the oil price shocks on local banks, and the propagation of the shocks through banks’ branching networks. Exposed banks with significant operations in oil-concentrated counties experienced a decline in demand deposit, a surge in credit line drawdowns, and a jump in troubled loans. Facing liquidity pressure, banks were forced to sell liquid assets, offer higher deposit rates, and reduce lending to small businesses and mortgage borrowers in unaffected markets. The effect is magnified when banks do not have strong community ties, while it is mitigated if banks have higher liquidity buffers, or sufficiently dispersed branching networks. I further document that healthy unexposed banks’ capacity to substitute credit supply is quite limited, providing fresh evidence from the perspective of bank competition.

Mathematics, Psychology, and Law: The Legal Ramifications of the Exponential Growth Bias
Zamir, Eyal,Teichman, Doron
Many human decisions, ranging from the taking of loans with compound interest to fighting deadly pandemics, involve phenomena that entail exponential growth. Yet a wide and robust body of empirical studies demonstrates that people systematically underestimate exponential growth. This phenomenon, dubbed the exponential growth bias (EGB), has been documented in numerous contexts, across different populations, using both experimental and observational methods. Despite its centrality to human decision making, legal scholarship has thus far failed to account for the EGB. This Article presents the first comprehensive study of EGB and the law. Incorporating the EGB into legal analysis sheds new light on legal measures that are already in use, and highlights new solutions to numerous problems that the law strives to solve. More concretely, the EGB calls for the introduction of new disclosure duties that would assist people grasp the long-term implications of their choices; the imposition of new mandatory rules that would minimize the exploitation of the EGB by savvy profit-maximizing entrepreneurs; and the adoption of new debiasing techniques that could improve policymakers’ decisions.

Modeling Credit Spreads: The Cross-Section Method Revised
Vermylen, Aurélien
The cross-section method for estimating credit spreads as proposed in [NOM01] has a drawback when used in applications different than estimating a CVA VaR. Indeed, we show that by optimizing in least-squares on log-spreads, the method tends to approximate the geometric average of observed spreads instead of the arithmetic average, which by the AMâ€"GM inequality will always be higher. This can lead to significant underestimation of Credit Risk if used carelessly in financial institutions. We thus propose an alternative methodology that optimizes on simple differences instead of log-differences.

Modern Information Technology and Firm Acquisitiveness: Evidence from EDGAR Implementation
Gu, Ming,Li, Dongxu,Ni, Xiaoran
Exploiting the staggered implementation of the EDGAR system from 1993 to 1996 as an exogenous shock to information dissemination technologies, we find evidence that internet dissemination of corporate disclosures reduces firm acquisitiveness. This effect is more pronounced for growth firms than value firms. In addition, EDGAR implementation discourages equity-based acquisitions and results in lower announcement returns, especially for growth firms. Our overall findings indicate that EDGAR implementation discourages managerial learning through dampening revelatory price efficiency, yielding inefficient acquisition decisions.

Pareto-optimal Reinsurance with Default Risk and Solvency Regulation
Boonen, Tim J.,Jiang, Wenjun
This paper studies an optimal reinsurance problem of Pareto-optimality when the contract is subject to default of the reinsurer. We assume that the reinsurer can invest a share of its wealth in a risky asset and default occurs when the reinsurer's end-of-period wealth is insufficient to cover the indemnity. We show that without the solvency regulation, the optimal indemnity function is of excess-of-loss form, regardless of the investment decision. We model solvency regulation as a constraint on the probability of default. Under solvency regulation, by assuming the investment decision remains the same as in the unconstrained solution, the optimal indemnity function is derived element-wisely. Partial results are given when the indemnity function and investment decision are jointly constrained by the solvency regulation. Numerical examples are provided to illustrate the implications of our results and the sensitivity of the solutions to the model parameters.

Predicting the Behavior of Dealers in Over-The-Counter Corporate Bond Markets
Yusen Lin,Jinming Xue,Louiqa Raschid

Trading in Over-The-Counter (OTC) markets is facilitated by broker-dealers, in comparison to public exchanges, e.g., the New York Stock Exchange (NYSE). Dealers play an important role in stabilizing prices and providing liquidity in OTC markets. We apply machine learning methods to model and predict the trading behavior of OTC dealers for US corporate bonds. We create sequences of daily historical transaction reports for each dealer over a vocabulary of US corporate bonds. Using this history of dealer activity, we predict the future trading decisions of the dealer. We consider a range of neural network-based prediction models. We propose an extension, the Pointwise-Product ReZero (PPRZ) Transformer model, and demonstrate the improved performance of our model. We show that individual history provides the best predictive model for the most active dealers. For less active dealers, a collective model provides improved performance. Further, clustering dealers based on their similarity can improve performance. Finally, prediction accuracy varies based on the activity level of both the bond and the dealer.

Premium Rating Without Losses: How To Estimate the Loss Frequency of Loss-Free Risks
Fackler, Michael
In insurance and even more in reinsurance it occurs that about a risk you only know that it has suffered no losses in the past e.g. seven years. Some of these risks are furthermore such particular or novel that there are no similar risks to infer the loss frequency from. In this paper we propose a loss frequency estimator that copes with such situations, by just relying on the information coming from the risk itself: the “amended sample mean”. It is derived from a number of practice-oriented first principles and turns out to have desirable statistical properties. Some variants are possible, which enables insurers to align the method to their preferred business strategy, by trading off between low initial premiums for new business and moderate premium increases for renewal business after a loss. We further give examples where it is possible to assess the average loss from some market or portfolio information, such that overall one has an estimator of the risk premium.

Pricing of debt and equity in a financial network with comonotonic endowments
Tathagata Banerjee,Zachary Feinstein

In this paper we present formulas for the valuation of debt and equity of firms in a financial network under comonotonic endowments. We demonstrate that the comonotonic setting provides a lower bound and Jensen's inequality provides an upper bound to the price of debt under Eisenberg-Noe financial networks with bankruptcy costs. Such financial networks encode the interconnection of firms through debt claims. The proposed pricing formulas consider the realized, endogenous, recovery rate on debt claims. Special consideration is given to the CAPM setting in which firms invest in correlated portfolios so as to provide analytical stress testing formulas. We endogenously construct the comonotonic endowment setting from a equity maximizing standpoint with capital transfers. We conclude by, numerically, comparing the network valuation problem with two single firm baseline heuristics which can, respectively, approximate the price of debt and equity.

Randentropy: a software to measure inequality in random systems
Guglielmo D'Amico,Stefania Scocchera,Loriano Storchi

The software Randentropy is designed to estimate inequality in a random system where several individuals interact moving among many communities and producing dependent random quantities of an attribute. The overall inequality is assessed by computing the Random Theil's Entropy. Firstly, the software estimates a piecewise homogeneous Markov chain by identifying the changing-points and the relative transition probability matrices. Secondly, it estimates the multivariate distribution function of the attribute using a copula function approach and finally, through a Monte Carlo algorithm, evaluates the expected value of the Random Theil's Entropy. Possible applications are discussed as related to the fields of finance and human mobility

Reinventing Pareto: Fits for All Losses, Small and Large
Fackler, Michael
Fitting loss distributions in insurance is sometimes a dilemma: either you get a good fit for the small/medium losses or for the very large losses. To be able to get both at the same time, this paper studies generalizations and extensions of the Pareto distribution. This leads not only to a classification of potentially suitable, piecewise defined, distribution functions, but also to new insights into tail behavior and exposure rating.

Relative Equity Market Valuation Conditions and Acquirers’ Gains
Andriosopoulos, Dimitris,Barbopoulos, Leonidas G.
We examine whether the relative equity market valuation conditions (EMVCs) in the countries of merging firms help acquirers’ managers to time the announcements of both domestic and foreign targets. After controlling for several deal- and merging firm-specific features we find that the number of acquisitions and acquirers’ gains are higher during periods of high-EMVCs at home, irrespective of the domicile of the target. We also find that the higher gains of foreign target acquisitions realized during periods of high- EMVCs at home stem from acquiring targets based in the RoW (=World-G7), rather than the G6 (=G7-UK) group of countries. We argue that this is due to the low correlation of EMVCs between the UK (home) and the RoW group of countries. However, these gains disappear or even reverse during the post-announcement period. Moreover, acquisitions of targets domiciled in the RoW (G6) countries yield higher (lower) gains than acquisitions of domestic targets during periods of high-EMVCs at home. This suggests that the relative EMVCs between the merging firms’ countries allow acquirers’ managers to time the market and acquire targets at a discount, particularly in countries in which acquirers’ stocks are likely to be more overvalued than the targets’ stocks.

Risk-dependent centrality in the Brazilian stock market
Michel Alexandre,Kauê Lopes de Moraes,Francisco Aparecido Rodrigues

The purpose of this paper is to calculate the risk-dependent centrality (RDC) of the Brazilian stock market. We computed the RDC for assets traded on the Brazilian stock market between January 2008 to June 2020 at different levels of external risk. We observed that the ranking of assets based on the RDC depends on the external risk. Rankings' volatility is related to crisis events, capturing the recent Brazilian economic-political crisis. Moreover, we have found a negative correlation between the average volatility of assets' ranking based on the RDC and the average daily returns on the stock market. It goes in hand with the hypothesis that the rankings' volatility is higher in periods of crisis.

Robust equilibrium strategies in a defined benefit pension plan game
Guohui Guan,Jiaqi Hu,Zongxia Liang

This paper investigates the robust {non-zero-sum} games in an aggregated {overfunded} defined benefit (abbr. DB) pension plan. The sponsoring firm is concerned with the investment performance of the fund surplus while the participants act as a union to claim a share of the fund surplus. The financial market consists of one risk-free asset and $n$ risky assets. The firm and the union both are ambiguous about the financial market and care about the robust strategies under the worst case scenario. {The union's objective is to maximize the expected discounted utility of the additional benefits, the firm's two different objectives are to maximizing the expected discounted utility of the fund surplus and the probability of the fund surplus reaching an upper level before hitting a lower level in the worst case scenario.} We formulate the related two robust non-zero-sum games for the firm and the union. Explicit forms and optimality of the solutions are shown by stochastic dynamic programming method. In the end of this paper, numerical results are illustrated to depict the economic behaviours of the robust equilibrium strategies in these two different games.

Tax-Loss Harvesting Under Uncertainty
McKeever, Daniel,Rydqvist, Kristian
Numerical calculations imply that tax-loss harvesting is valuable to holders of taxable stock accounts. These calculations are based on the assumption that a capital loss on a stock portfolio can always be netted against ordinary income (up to a limit) or a capital gain on the same stock portfolio. We provide market-based evidence that a capital loss that is realized in the beginning of the year is substantially less valuable than a loss that is taken at the end of the year. A simple binomial tree model that captures the resolution of tax rate uncertainty closely mimics observed market prices. Allowing investors to postpone unused losses into the future does not alter the conclusion that realized losses are less valuable early in the year.

The Adoption of Blockchain-based Decentralized Exchanges: A Market Microstructure Analysis of the Automated Market Maker
Agostino Capponi,Ruizhe Jia

We analyze the market microstructure of Automated Market Maker (AMM) with constant product function, the most prominent type of blockchain-based decentralized crypto exchange. We show that, even without information asymmetries, the order execution mechanism of the blockchain-based exchange induces adverse selection problems for liquidity providers if token prices are volatile. AMM is more likely to be adopted for pairs of coins which are stable or of high personal use for investors. For high volatility tokens, there exists a market breakdown such that rational liquidity providers do not deposit their tokens in the first place. The adoption of AMM leads to a surge of transaction fees on the underlying blockchain if token prices are subject to high fluctuations.

The Banking Sector and National Economy
Uddin, Godwin,Ashogbon, Bode,Martins, Bolaji,Momoh, Omowumi,Agbonrofo, Hope E.,Alika, Samson,Oserei, Kingsley
The banks are central elements of a market economy. In more than one way, they facilitate business transactions by acting as depositor and lender for many actors in the domestic and international economy. The banking industry in Nigeria has expanded in size in terms of assets in the last 60 years since the country’s independence from British colonial rule and undergone large-scale reforms vis a vis transformation in the global economy. What are the dimensions of this growth? How has it affected market efficiency and economic wellbeing of the people? This article provides answers to these questions and argue that growth has indeed happened in the banking sector by a quantification of liquid assets, investment securities and loans. It also captured its transnational dimension and how that has boosted international transactions as well as repatriation of Diaspora transfers to the national economy. This article also focused on the contradictions of the economy arising from inconsistent policies of government and meddlesomeness of global financial institutions, and their impact on the banking sector. This article ends on a prescriptive note by suggesting ways to make the banking sector more relevant in promoting productive activities in the national economy.

The Check Is in the Mail: Can Disclosure Reduce Late Payments to Suppliers?
Chuk, Elizabeth,Lourie, Ben,Yoo, Il Sun
A common corporate cash management strategy is to delay payments owed to suppliers. We examine whether buyers pay suppliers faster in response to a recent regulatory change in the United Kingdom that mandates the public disclosure of buyers’ payment practices. We find that after the regulatory change, UK firms subject to this regulation shortened their payment periods relative to several control samples of firms that were not subject to the regulation. In cross-sectional tests, we predict and find that this shortening of the payment period is attenuated for firms that are less able to bear the costs of paying suppliers faster. Specifically, we find that the reduction in the payment period is smaller for buyers that (i) have longer operating cycles, (ii) depend more heavily on trade credit as a source of external financing, and (iii) pay dividends. In supplemental tests using proprietary data, we find that buyers subject to this regulation reduced their trade credit that is overdue by 30 days or more. However, this reduction is partially offset by an increase in the trade credit that is overdue by less than 30 days. Our findings are important in light of the ongoing debate in other regimes (e.g., the United States) on whether to require additional disclosures of trade credit.

The Earnout Structure Matters: Takeover Premia and Acquirer Gains in Earnout Financed M&As
Barbopoulos, Leonidas G.,Adra, Samer
In this article, based on both parametric and non-parametric methods, we provide a robust solution to the long-standing issue on how earnouts in corporate takeovers are structured and how their structure influences the takeover premia and the abnormal returns earned by acquirers. First, we quantify the effect of the terms of earnout contract (relative size and length) on the takeover premia. Second, we demonstrate how adverse selection considerations lead the merging firms to set the initial payment in an earnout financed deal at a level that is lower than, or equal to, the full deal payment in a comparable non-earnout financed deal. Lastly, we show that while acquirers in non-earnout financed deals experience negative abnormal returns from an increase in the takeover premia, this effect is neutralised in earnout financed deals.

The Impact of Margin Requirements on Voluntary Clearing Decisions
Onur, Esen,Reiffen, David,Sharma, Rajiv
We analyze the determinants of financial entities’ choices of whether to voluntarily designate trades for central clearing. In particular, we evaluate the impact of the Uncleared Margin Rule (UMR) on the trading and clearing decisions of firms transacting in the multi-trillion-dollar cash-settled foreign exchange swap markets. The UMR is a multi-jurisdiction rule that requires certain market participants to exchange collateral (margin) for uncleared transactions between themselves. We specifically study the effect of this rule for non-deliverable forwards (NDF) since similar contracts â€" FX deliverable forwards and swaps - are exempt from the rule in the U.S. and hence constitute a useful control group. In a difference-in-differences setting, we find that compared to FX forwards and swaps, the UMR resulted in firms choosing to clear a higher percentage of their swaps in the NDF market. To understand the forces behind firms’ clearing decisions, we make use of a regulatory data set that includes the identities of the parties to each swap. We show that increased clearing is due almost exclusively to the actions of clearing members, suggesting that the differential cost of clearing for these entities plays a major role in clearing decisions. Consistent with theory, we find the ability to net swap exposure at the central clearing party is one of the drivers behind the decision to clear.

The Impact of Monetary Policy on M&A Outcomes
Adra, Samer,Barbopoulos, Leonidas G.,Saunders, Anthony
Monetary policy influences a wide range of Mergers and Acquisitions (M&A) outcomes. First, an increase in the federal funds rate predicts a negative market reaction to M&A announcements, an increase in the likelihood of deal withdrawal, and significant financing challenges for the acquirer in the post-acquisition phase. Second, M&As announced during periods of high monetary policy uncertainty are associated with significant declines in acquirer value. This negative market reaction reflects a unique discount to compensate for the high riskiness of M&As in an uncertain monetary environment. Finally, we show that monetary contraction, rather than monetary policy uncertainty, is a key contributor to the decline in the aggregate M&A activity.

The Influence of Policy Uncertainty on Exchange Rate Forecasting
Smales, Lee A.
Using the economic policy uncertainty (EPU) index of Baker et al. (2016), we examine the influence of EPU on the characteristics of USD/JPY exchange rate forecasts. Our sample period, which spans two decades, incorporates a range of economic and political conditions for the US and Japan. Consistent with higher EPU engendering a more complex information environment, our results clearly demonstrate that analyst forecast errors, and forecast dispersion, increase with EPU. US monetary policy uncertainty and Japanese trade policy uncertainty are particularly important in generating forecast dispersion. The empirical findings are consistent across forecast horizons ranging from 1-month to 1-year. This has important implications for market participants who use exchange rate forecasts when making business and investment decisions.

The Role of Real Options in the Takeover Premia in Mergers and Acquisitions
Barbopoulos, Leonidas G.,Cheng, Louis T. W.,Cheng, Yi,Marshall, Andrew P.
This paper applies a real option framework to suggest that the takeover premia in mergers and acquisitions can be influenced by (a) the pre-bid ownership of target and (b) the real option characteristics of both acquirer and target firms. Our findings show that pre-bid ownership reduces the takeover premia, which is consistent with the argument that pre-bid ownership reduces in- formation asymmetry. However, we find that the takeover premia is higher when both the acquirer and target firms exhibit real option capacity as measured by positive risk-return sensitivity. As a result, an acquirer with real option capacity is willing to pay higher takeover premia for an option embedded in the target firm.

The Structure of the Board of Directors: Boards and Governance Strategies in the US, the UK and Germany
Hopt, Klaus J.,Leyens, Patrick C.
The chapter continues and advances our earlier research on ‘Board Models in Europe’.** We explore ‘The Structure of the Board of Directors’ with a view to the basic governance structure as provided by a board model vis-à-vis techniques of structuring the decision-making body, which can be used independent of the chosen board model. We focus on boards of large business corporations with a stock exchange listing to secure cross-country comparability. Our three sample jurisdictions are the US, the UK and Germany. France and Italy are also considered to round out the discussion of selected issues. Our key findings are as follows:1. Board models like the one-tier board, as used in the US and the UK, or the two-tier board, as used in Germany, provide a basic governance structure that enables the use of specific governance strategies. It is the use of specific governance strategies, not the choice of a board model, which determines the role of the board in alleviating agency problems between owners and managers, controlling and non-controlling shareholders, and shareholder and stakeholder constituencies. Based on this finding, the choice of the suitable board model should be left to private parties.2. The market for corporate control is known as a removal strategy that alleviates the agency problem between owners and managers of potential target companies. To achieve this effect, it must be ensured that takeover defenses are adopted in the interest of shareholders rather than as a means to shield the incumbent board from removal by the acquirer. The governance options include focusing the board structure through the allocation of decision-making power to independent directors (US) or to the supervisory board (Germany), and, as an alternative, reinstalling shareholder decision-making and thus removing the board from its coordination task (UK). Counter-intuitively, one might group US and German law together, despite differences in their basic board structures and despite the European Union’s adoption of UK-style control shift regulation.3. The three sample jurisdictions follow a similar pattern for securing fairness of related party transactions (RPTs). The UK relies on a structuring of the shareholder body, requiring ex-ante approval of the disinterested shareholders (MOM approval), a strategy that is also used in France but in a weaker form due to the possibility of ex-post authorization. In the US, the predominant choice seems to be structuring the board so as to leave the decision to independent directors, a strategy that Italy has, on one hand, sought to enhance with the obligatory involvement of a minority appointed director but, on the other hand, has weakened by allowing the board to override a recommendation of the independent directors. Germany also relies on board structuring in that it requires supervisory board approval of RPTs, but compared to the use of independent directors, the cooperation between the two boards provides a basis for manager-friendly results one would expect only from a jurisdiction that openly promotes board empowerment.4. The most far-reaching advance of the corporate purpose debate relates to a further structuring of the board so as to provide employee representatives with a voice, as known from German co-determination. Proposals to reallocate a proportion of the appointment rights from shareholders to employees have not found their way into legal reform in the US or the UK. Out of the governance strategies discussed in this chapter, it is only employee co-determination that calls for a basic governance structure which solely a two-tier board model can provide.

The Valuation Effects of Investor Attention in Stock-Financed Acquisitions
Adra, Samer,Barbopoulos, Leonidas G.
Limited investor attention allows overvalued companies to engage in stock-financed acquisitions of listed target firms without experiencing significant reductions in existing valuations. Our robust findings show that overvalued stock-paying acquirers that are subject to limited investor attention do not experience significant announcement period wealth losses. However, the overvaluation of these acquirers is corrected in the post-announcement period. By contrast, the overvalued acquirers that receive high investor attention and use stock as the payment method in their listed target acquisitions experience negative announcement period abnormal returns. The widely documented evidence that stock-financed acquisitions are associated with significant announcement period wealth losses is primarily driven by deals in which the acquirers are subject to high investor attention.

The Value of Countercyclical Capital Requirements: Evidence from COVID-19
Koont, Naz,Walz, Stefan
We evaluate the implications of relaxing the Supplementary Leverage Ratio during the COVID-19 market disruption for bank balance sheet composition and credit provision. To the best of our knowledge, we are the first to causally identify the effect of the SLR regulation change on bank level outcomes. We find that the relaxation may have eased Treasury market liquidity by allowing banks to hold modestly greater inventories of Treasuries, and further allowed for a significant expansion of traditional bank credit. Our findings suggest that this risk-invariant leverage ratio was binding for banks during COVID-19, weakly affected bank liquidity provision in Treasury markets, and strongly affected banks' portfolio composition across asset classes, amounting to a shift of banks' loan supply schedules. Thus, we highlight that countercyclical relaxation of uniform leverage constraints can increase bank credit provision during economic downturns. Given the binding nature of the SLR, the relaxation of this constraint may be more effective than other countercyclical measures in allowing banks to extend credit.

Voice at Work
Harju, Jarkko,Jäger, Simon,Schoefer, Benjamin
We estimate the effects of worker voice on job quality and separations. We leverage the 1991 introduction of worker representation on boards of Finnish firms with at least 150 employees. In contrast to exit-voice theory, our difference-in-differences design reveals no effects on voluntary job separations, and at most small positive effects on other measures of job quality (job security, health, subjective job quality, and wages). Worker voice slightly raised firm survival, productivity, and capital intensity. A 2008 introduction of shop-floor representation had similarly limited effects. Interviews and surveys indicate that worker representation facilitates information sharing rather than boosting labor’s power.

Why ROE, ROA, and Tobin’s Q in Regressions Aren’t Good Measures of Corporate Financial Performance for ESG Criteria
Gregory, Richard Paul
It is demonstrated theoretically why ROE, ROA, and Tobin’s Q aren’t good measures of corporate financial performance for ESG criteria. Essentially due to E, S, and G criteria affecting productivity and debt costs, this causes measurement error in the dependent variables of regressing ROE, ROA, and Tobin’s Q on E, S, and G criteria where the measurement error is correlated with the independent variables. This results in biased estimators and inflated standard errors.