Research articles for the 2021-03-19

Algorithms put to test: Control of algorithms in securities trading through mandatory market simulations?
Raschner, Patrick
In the European Union, the algorithmic trading regime introduced by MiFID II requires firms to test and simulate their algorithms before deploying them on the market. While there have been important contributions to the overall scope of the EU algorithmic trading regime, the new testing requirements have remained largely untested by scholars. Against this background, the first half of this paper examines the algo testing framework from a legal perspective. This includes the way algorithms must be tested, the testing environments, the responsibilities of the market participants and the role of the supervisory authorities. It is showed that although being generally quite prescriptive, the crucial elements for the control of algorithms remain too vague. Subsequently, the paper seeks to evaluate whether testing can help to control algorithms in securities trading from a regulatory policy perspective. To do this, three issues are explored: firstly, the possibility of firms to choose the testing process themselves (including in-house testing), leading to questions regarding self-regulation; secondly, the overall effectiveness of the testing regime, in light of the interactions algorithms have with the market; finally, implications of the use of algorithmic trading systems based on AI or ML. The central findings suggest that clearer rules regarding (self-)testing are desirable and that only network-sensitive market simulations can help to control algorithms in securities trading.

Alpha FTS Submission to the UNGASS Against Corruption 2021
Sheldon-London, Monika
Proposal to the United Nations General Assembly Special Session Against Corruption 2021: Receivership without disposition for recovery of qualified assets. Polytechnic Engineering education and concept introduction for Multilateral PMO establishment.Alpha FTS would like to thank the United Nations Convention against Corruption (UNCAC) Conference of State Parties and the United Nations Office on Drugs and Crime (UNODC) for the opportunity to participate in this important consultation process in preparation for the UN General Assembly Special Session against Corruption 2021 (UNGASS 2021).

Analysis of Forecasting Models in an Electricity Market under Volatility
Uddin, Gazi Salah,Sahamkhadam, Maziar,Taghizadeh-Hesary, Farhad,Yahya, Muhammad,Tang, Ou,Cerin, Pontus,Rehme, Jakob
Short-term electricity price forecasting has received considerable attention in recent years. Despite this increased interest, the literature lacks a concrete consensus on the most suitable forecasting approach. We conduct an extensive empirical analysis to evaluate the short-term price forecasting dynamics of different regions in the Swedish electricity market (SEM). We utilized several forecasting approaches ranging from standard conditional volatility models to wavelet-based forecasting. In addition, we performed out-of-sample forecasting and back-testing, and we evaluated the performance of these models. Our empirical analysis indicates that an ARMA-GARCH framework with the student’s t-distribution significantly outperforms other frameworks. We only performed wavelet-based forecasting based on the MAPE. The results of the robust forecasting methods are capable of displaying the importance of proper forecasting process design, policy implications for market efficiency, and predictability in the SEM.

Bank Loans During the 2008 Quantitative Easing
Lu, Chien-Lin,Chou, Robin K.,Lin, Chih-Yung,Lu, Chien-Lin
We examine the effect of quantitative easing on the supply of bank loans. During the 2008 quantitative easing, lending banks reduce relatively more loan spreads, offer longer loan maturities, provide larger loans, and loosen covenants for firms whose long-term bond ratings are lower than BBB. Furthermore, we find that new bank loans in this period are associated with the reduction of a firm’s value and the increase of default risk. The results indicate that banks take greater risk during the 2008 quantitative easing by relaxing lending standards to relatively riskier borrowers.

Banking Supervision and Risk-Adjusted Performance in the Host Country Environment
Janda, Karel,Kravtsov, Oleg
We study the effect of the banking supervision in institutional settings of foreign-bank dominated financial systems of Central, Eastern and South-Eastern Europe in post-crisis period 2012-2018. For a dataset of 450 banks from 20 economies of the region, we use a mediation-moderation analysis framework to establish a relationship between regulatory scrutiny, supervisory activities and a bank risk-adjusted economic performance. We find that a higher intensity of supervision monitoring activities, especially by the centralized form of supervision, contributes to the decline of the bank's riskiness in case of larger size banks while not affecting their economic performance. The regulatory power and capital regulation stringency indicate a positive effect on the risk-adjusted performance for capital constrained banks, but moderately decrease the economic benefit for larger banks. In light of the ongoing debate on the architecture of supervision in the region, the findings highlight the potential area of attention for regulators and policymakers and thus, contribute to the designing of effective supervision mechanism.

Business Law in Europe after Brexit. The Need for Legal Transnationalisation in the International Market Place. The Example of International Assignments
Dalhuisen, Jan Hendrik
After Brexit, legislators, practitioners, and legal scholars in the EU have to reconsider what may be legally needed to support business increasingly conducted in or from the EU rather than from London. The further question is then to what extent common law can remain dominant through a party choice of law and provide unity especially in proprietary and regulatory matters to overcome the basic conflicts of law approach still cutting up transactions in the international business flows into local parts depending on closest connections in the hope that these legal pieces together still present an adequate legal framework for the business as a whole. More fundamentally, in all international commerce and finance, therefore in professional dealings, key building blocks of private law may need reconsideration, especially new financial structures and funding mechanisms, to operate and find more universal legal support. This goes well beyond the EU and the UK and affects all national legal systems connected with the international flows in goods, services, money, information and technology and its operation, therefore also the U.S, South America, Japan, China, South Korea, Singapore, India, Indonesia, and many others. It is submitted that transnationalisation of private law is here the more ready and efficient tool and way forward especially in trans-border manufacturing, supply, and distribution chains by accepting, on the one hand, the legal unity of international business transactions and, on the other, the direct application of international fundamental and general principle, custom and market practices, and a strong form of party autonomy subject to transnational minimum standards of behaviour in the international market place. Although the common law is closer to the international markets, which derives in contract and moveable property law from its origin in commerce and has in equity greater flexibility especially in property law, it needs to respect the rules of the international markets and its legal structures just as much to remain truly relevant and move forward. It means that these are issues no less relevant to international business when connected with the US, the UK, Canada, or Australia or made subject to a contractual choice of their laws. This article attempts to meet this challenge for international assignments of portfolios of monetary claims with assignees in other countries and debtors in many. It is a vital part of the international financial infrastructure.

Catastrophic Risk Modeling for Risk Strategy Execution: Extreme Risk Models and Methods: Cyber Finance to Cyber Warfare Risk Modeling for Managing Exponential Uncertainty and Complexity in Increasingly Non-Deterministic Cyberspace
Malhotra, Yogesh
Recently, such probabilistic, statistical, and numerical methods related concerns are in globally popular press related to cybersecurity controls and compliance. Earlier, similar probabilistic, statistical, and numerical methods related concerns were in the global popular press in the context of the global financial crisis. Future questions focused on the underlying assumptions and logic may focus on related implications for compliance, controls, valuation, risk management, etc. Likewise, recent developments about mathematical entropy measures shedding new light on apparently greater vulnerability of prior encryption mechanisms may offer additional insights for compliance and control experts. For instance, given related mathematical, statistical and numerical frameworks, analysis may also focus on potential implications for pricing, valuation and risk models. The important point is that many such fundamental assumptions and logic underlying widely used probabilistic, statistical, and numerical methods may not as readily meet the eye.

Centralizing Over-the-Counter Markets?
Wittwer, Milena,Allen, Jason
In traditional over-the-counter (OTC) markets investors trade bilaterally through intermediaries, called dealers. An important regulatory question is whether to centralize OTC markets by shifting trades onto centralized platforms. We address this question in the context of the Canadian government bond market, which is liquid and price-transparent. We document that, even in this market, dealers charge substantial markups when trading with investors. We also show that there is a price gap between large investors who have access to a centralized platform and small investors who do not. We specify a model to quantify how much of this price gap is due to platform access, and assess welfare effects. The model predicts that not all investors would use the platform, even if platform access were universal. Nevertheless, the price gap between small and large investors would close by 35-52%. Further, total welfare would increase by 9-30% because the platform better allocates high-valued buyers to low-valued sellers.

Certain Safeties or Safe Certainties: Infrastructure Reliability versus Rewards
Mainelli, Michael,Harris, Ian
Public sector entities devote a tremendous amount of time to avoiding risk, especially political risk. It feels far safer to spend a large number of small sums of money on ten different studies, rather than solve one problem for the same cost. If a political problem arises, then the response “we had it under review” is of more political value than “we ignored nine similar problems because we hoped to eliminate one long-term problem once-and-for-all, but this one of the nine caught us out”. Infrastructure, however, needs to be reliable, not a subject of political whimsy or backside-covering. How can we go about setting public policy that sensibly balances risks, rewards and reliability of infrastructure? Risk/Reward management defines three types of activity that improve organizational performance - risk avoidance, reward enhancement and volatility reduction. Risk avoidance activities reduce large exposures, e.g. continuity planning, insurance or legal compliance. Reward enhancement activities are normal management projects to increase performance such as training, cost reduction or production improvement. Volatility reduction is more subtle, yet activities that reduce volatility or improve consistent delivery add measurable value.

Considerations on the application of the NCWO principle under the SRM Regulation
Gortsos, Christos
The aim of this article is to make certain specific considerations on the application of the‘no creditor worse off (NCWO) principle’ (or safeguard) under the Regulation governing the SingleResolution Mechanism and the Single Resolution Fund (SRMR). Even though the field of applicationof the SRMR also covers other financial firms, the article’s focus, which is structured in four sections, is (solely) on credit institutions.Section 1 overviews the provisions of the SRMR dealing with the third resolution condition, namelythe public interest criterion, on the basis of which the decision is taken by the Single ResolutionBoard whether a credit institution determined as failing or likely to fail should be resolved or woundup. It is only when the public interest criterion is met and the Board takes a decision on the resolution of the credit institution concerned, that the NCWO principle is applicable. Section 2 discusses the provisions governing the NCWO principle under international and EU banking law. In this respect, after a brief overview of the international financial standards adopted by the Financial Stability Board (FSB) on banking resolution, including on the NCWO principle (under 2.1), this principle is analysed as a general principle governing resolution under the SRMR; its perimeter of application and the obligations imposed on national resolution authorities (NRAs) in this respect are also discussed (under 2.2). The following two sections deal then, in turn, with two specific aspects of application of the NCWO principle under the SRMR: mandatory and optional exclusion of deposits from bail-in (Section 3), as well as ex-ante and ex-post valuations for the purposes of resolution (Section 4). The final Section 5 concludes.

Corporate Vote Trading in Australia
Ang, Tze Chuan 'Chewie',Li, Tongxia
This study finds that institutional investors in Australia recall loaned shares prior to shareholder meetings to exercise their voting rights as part of their effort to improve corporate governance. Recalls are increasingly common in larger firms, firms with more independent directors, and stocks with higher past returns in recent years. Recalls are associated with less support for resolutions at meetings, especially those related to the remuneration package in firms within the ASX100 and those with existing shareholder dissent. We deduce the value of votes (around 351 bps per annum) from the incremental cost of borrowing shares with voting rights around shareholder meetings.

Debt and Stock Market Participation
Jones, Scott
Wealth is widely considered the most important rational determinant of stock market participation. I propose that wealth â€" defined as assets less debt â€" captures both rational participation costs and behavioral factors. Specifically, evidence shows that debt captures impulsivity and moral licensing. Using data from the American Life Panel, I show that debt has a larger absolute effect on stock market participation than assets, suggesting wealth has a behavioral component. I also find that impulsivity and moral licensing are potential channels through which debt affects stock market participation.

Do Managers Use Reference Points? Evidence from Stock Repurchases
Clarke, Nicholas,Norris, Dylan,Schrowang, Andrew
The extent to which managers use reference points in their corporate decisions remains an open question in the literature. This paper studies the effect of managerial reference points on actual share repurchases. We argue share repurchases are an ideal setting to study managerial reference points because repurchase prices are salient to managers and actual share repurchases typically occur as a sequence of events. We find that the percent change from the prior repurchase price to the current stock price is negatively related to the current level of repurchases. To facilitate a causal interpretation, we find that this relationship disappears when the prior repurchase price is associated with a previous manager. These results are consistent with the idea that managers use past repurchase prices as reference points for current repurchase decisions.

Endogenous Information Collection: The Study of a Limited Liability Credit Market
Das Chaudhury, Ratul,Bhattacharya, Sukanta
We analyze a limited liability credit market where the borrowers need to borrow to implement their chosen projects with uncertain outcome. We allow borrowers to invest in resolution of the uncertainty in the project outcome before implementing the project. Our paper provides a complete characterization of the borrowers’ decision on investment in information for uncertainty resolution and project implementation. We show that the borrowers have more incentive to invest in information at higher rates of interest. If the cost of information goes down a borrower’s incentive to collect information increases. We also show that even a socially motivated lender may decide to charge a relatively high rate of interest and make positive profit under specific parameter values. Although a higher rate of interest induces the borrowers to choose relatively riskier projects.

Environmental Disclosure Practices and Firm Performance; Evidence from Sri Lanka
Nimanthi, D.K.S.,Priyadarshanie, Nadeesha
The main objective of this study was to identify the impact of environmental disclosure practices on firm performance which is an emerging issue around the globe. This research relies on secondary data which was collected from published annual reports of listed companies in the Colombo Stock Exchange (CSE). Data was collected from a sample of 50 companies listed under 5 sectors over consecutive four financial years from 2015 to 2018. The technique of content analysis was occupied when measuring the level of environmental disclosures. Environmental Disclosure Index (EDI) was prepared based on the Global Reporting Initiative (GRI) Standards 2019. This study employed a regression analysis for the data analysis. The findings of this study revealed that there is a significant positive relationship between environmental disclosures and firm financial performance. However, there is no significant relationship between environmental disclosures and firm market performance. The findings of this study will accommodate annual report preparers and regulators of highly environmentally sensitive industries in creating the grounds of environmental disclosures practice to achieve higher performance.

Euro Area Banking and Monetary Policy Shocks in the QE Era: A Structural Credit Risk and Vector-autoregression Approach
Kabundi, Alain Ntumba,Nadal De Simone, Francisco
This paper assesses the effects of monetary policy shocks on the macroeconomy and the euro area banking sector after the global financial crisis. Financial risk-return indicators of the banking sector based on a compound option-based structural credit risk model are embedded in a large macro-financial quarterly database covering the period 2008Q4-2019Q4. A SFAVAR identifies and estimates the shocks’ responses relating them to the endogenous build-up of banks’ vulnerabilities. The study finds that unconventional monetary policy, in particular the Asset Purchase Program of the European Central Bank, seems to have been more successful than conventional monetary policy in raising output and inflation. The desired boost to bank lending has been muted and loan cyclicality has varied across countries and loan types. The performance of the banking sector following monetary policy shocks can be characterized by a drop in expected ROE and ROA, a relaxation of lending conditions and increased correlation between banks’ assets return and the market return, a mechanism pointing to enhanced risk-taking. While banks’ probabilities of default fall following monetary policy shocks, financial leverage and the price of risk increase. Banks’ net worth rises via higher market capitalization and implied assets value together with lower volatility, albeit often incurring more debt. Risk-taking in the banking sector, such as the one observed in the run-up to the global financial crisis, may pose a risk to financial stability, especially if its effects on banks’ vulnerability spread to systemic risk. The endogenous build-up of macro-financial vulnerabilities may need to become part of monetary policymaking.

Fifty Shades of QE: Comparing Findings of Central Bankers and Academics
Fabo, Brian,Jancokova, Martina,Kempf, Elisabeth,Pastor, Lubos
We compare the findings of central bank researchers and academic economists regarding the macroeconomic effects of quantitative easing (QE). We find that central bank papers find QE to be more effective than academic papers do. Central bank papers report larger effects of QE on output and inflation. They also report QE effects on output that are more significant, both statistically and economically, and they use more positive language in the abstract. Central bank researchers who report larger QE effects on output experience more favorable career outcomes. A survey of central banks reveals substantial involvement of bank management in research production.

Financial Resilience in Labor Negotiations
Piccolo, Alessio,Pinto, Roberto
We investigate the use of financial resilience as a strategic tool in labor negotiations. In a dynamic model of employer-employee negotiations, low leverage and long-term maturity improve a firm's ability to withstand strikes. If employees suffer more from negotiations, this improved resilience strengthens the employer's bargaining position. Using data on union elections and policy changes, we find that firms increase (decrease) debt maturity in response to higher (lower) employees' bargaining power while keeping leverage unchanged. In contrast to previous studies, our findings indicate that firms respond to more powerful employees by increasing their financial resiliency to negotiations and strikes.

Husbands, Wives, and Perception of Relative Knowledge About Household Finances
Hanna, Sherman D.,Kim, Kyoung Tae,Lindamood, Suzanne,Lee, Sunwoo T.
Which spouse is more knowledgeable about the household’s finances in mixed-sex married couple households? The answer to this question can be inferred from the Survey of Consumer Finances (SCF), which assigns the title of “respondent” to the person the household indicates is more knowledgeable about its finances. In the 2016 SCF, the husband was the respondent in 56% of husband-wife households, but among households in the top 1% of net worth, the husband was the respondent in 90% of the households. Despite the progress women have made in education and other aspects of society, husbands were the respondent in a higher percent of households in 2016 than in 1992, and the husband was much more likely to be the respondent in wealthy households. Logistic regression on whether the husband or wife was the respondent showed a strong effect of the spouse with more education being the respondent.

Impact of Dividend Policy on Stock Price Volatility and Market Value of the Firm: Evidence From Sri Lankan Manufacturing Companies
Gunarathne, UGVDD,Priyadarshanie, Nadeesha,Samarakoon, S.M.R.K.
The impact resulted from the dividend policy of a firm on the volatility of the market value of stocks is the major concern of this study, which is an issue bearing the utmost significance, when considering the objectives of a corporate. The focus of an entity should be aligned on the maximization of stockholders’ wealth and this necessitates the selection of an optimum dividend policy. The present study, thus, attempts to shed a light on the above fact within the Sri Lankan context. Data was collected from a sample of companies listed under the manufacturing sector of the Colombo Stock Exchange from the year 2006 to 2014. The study occupied panel data regression model for analysis. The outcome revealed that the dividend yield of the current year has a negative impact on the share price volatility, while the dividend payout ratio of both the current and previous years has a positive impact. In addition, the impact of dividend yield is negative on the market value of the firm, where the dividend payout ratio of the current year also depicts the same impact. The findings of the study reassure the findings of the previous researchers within the Sri Lankan context in case of the market value of the firm while being contrary in case of the share price volatility. Accordingly, the firms’ ability to utilizing the dividend policy as a mechanism of controlling the volatility of share prices is established. However, it will not be effective in altering the market value of the firm.

Impact of Negative Oil Price on Stock Markets of Major Oil Importing and Exporting Countries
Umar, Muhammad
WTI crude oil FOB spot price was recorded to be negative $36.98 per barrel on April 20, 2020. Apparently, it seems to be a good news for oil importers and a bad one for oil exporters. However, the results of event study analysis of indices data ranging from July 1, 2019 to August 17, 2020 presents a different picture. The incidence of negative oil price had negative impact on stock markets of both, major oil importing and exporting countries. Cumulative abnormal returns measured on the basis of market factor of CAPM were significantly negative for all the indices for all three selected event windows.

Inequality in Productivity: Geography and Finance of Leaders and Laggards in Italy
Navaretti, Giorgio Barba,Rosso, Anna
We examine the geography of productivity leaders and laggards in the population of Italian joint stock manufacturing companies between 2007 and 2017 and analyse how far such patterns can be related to their financial structure and the provision of financial services in the Italian provinces. To do so we exploit the reform of the Italian banking system in the mid-Nineties as an exogenous shock on the structure of local banking markets and examine whether this shock affects productivity patterns at the firm level. We find a robust descriptive evidence of a widening of the leader-laggard gaps, with a very sizeable productivity divide between the North and the South of the country. Leaders are concentrated in the North. Leaders, especially in the North are also more likely to have access to capital markets. Firms in the South, instead, also those at the frontier, are more reliant on bank lending. The liberalization of the banking market in the mid 90s and the growth of joint stock banks at the provincial level positively affected firms' productivity outcomes, possibly through an improvement of firms' financial structure. We also use a firm specific measure of core-periphery based on distance from airport hubs and find that the likelihood of activating a virtuous capital market productivity link declines with distance from core areas.

Information Absorption in Stocks with Short-Selling Constraints
Floros, Ioannis V.,Singh, Ajai K.,Suzuki, Katsushi
In an efficient market with unrestricted trading, information is expected to be absorbed into stock prices without delay. However, we document a phenomenon under short-sales restrictions, where the market reacts again to publicly available adverse information, to which it has already responded before. It is best explained by a heterogeneity of investors, where pessimistic investors’ response is initially stifled due to short-sales constraints. To identify and scrutinize the phenomenon, we employ a Japanese dataset endowed with distinctive regulatory features pertaining to trading restrictions for a subset of stocks, and unique regulations governing seasoned equity offers (SEOs). Specifically, a Japanese SEO’s issue date, by regulation, is a minimum of five trading days from its pricing date. Further, in Japan, unlike the U.S., both the price and quantity are already known prior to the offering’s issue date. We posit that when an SEO is announced for short-sales restricted stocks, pessimistic investors are initially kept at abeyance and restricted from responding freely to the offering-related adverse information, until the issue date. When the influx of additional shares occurs, pessimistic investors are finally engaged on the SEO’s issue date, and they trade at their lower reservation prices. The price reaction manifested on the issue date, to the now stale information to which the market has already reacted at its announcement, is akin to a “supply effect”. The phenomenon is attributable to a delayed reaction to publicly available information, manifested only when additional shares are introduced.

Labor Unionization and Real Earnings Management: Evidence from Labor Elections
Chen, Tao,Qu, Jimmy Chengyuan
By exploiting the local randomness in close-call labor elections, this paper finds a positive impact of labor unionization on firms’ real earnings management, suggesting the pressure effect of increased labor power. In a local regression discontinuity (RD) analysis, firms that narrowly pass the 50% threshold show a higher increase of real earnings management than those that narrowly fail. This effect is attenuated for firms in right-to-work states and is strengthened when managers face higher pressure on earnings. Evidence from a global parametric RD analysis and a multivariate OLS test using industry-level and firm-level unionization information confirms the external validity of results in local RD analysis. Overall, this paper sheds new light on the economic consequence of labor unionization in terms of employers’ accounting decisions.

Large Shareholder Premium
Huang, Weihuan,Ma, Chenghu,Xu, Yuhong
We develop a theoretical model to study investors' trading behavior in the presence of large shareholders' influence on a firm's equity. We show that, for a good stock, large shareholders may invest a higher proportion of their wealth in the firm than smart small investors, although they predict the same equity return. Insight is also cast into the impacts of board structure on the firm's equity when the firm possesses several large influential shareholders: (i) the large shareholders collude in trading, and each tends to invest more aggressively as other large shareholders do, and (ii) firms with sole ownership can outperform those with dispersed ownership, if the impact coefficient of the former case exceeds or coincides with the aggregated impact coefficients of the latter.

Managerial Sentiment and Employment
Montone, Maurizio,Zhu, Yuhao,Zwinkels, Remco C. J.
We study firms' hiring decisions in a world in which both managers and investors are prone to expectation errors. We show that high managerial sentiment increases employment growth, especially at firms with worse investment opportunities and low-quality corporate governance, and during times of low investor sentiment. Using data on U.S. publicly traded companies and CEO option holdings, we find evidence consistent with these predictions. The results unveil a new channel through which managerial sentiment affects firms' operations, and suggest that managerial optimism can counter the negative effect of pessimistic investors on labor markets.

Modeling Carbon Emission Allowance Trading in China’s ETS
wu, Hongjun,Chen, Lingju,Tang, Qingliang
This paper develops a game model to depict the process of determining the trading price and volume at equilibrium of Chinese carbon emission allowance trading market. Assuming that the cost for carbon emission reduction is a normally distributed random variable, enterprises are risk-neutral, and the total quantity of emissions allowances for the whole carbon market is a given, exogenous variable, carbon emission allowance price is a linear function, the model shows that CO2 price and volume are both affected by the magnitude and variance in the carbon reduction costs borne by companies and the reduction targets of the government. More specifically, the ratio between variances in costs and in reduction targets is associated with the speed of changes in CO2 price and rate of change in CO2 volume. This theoretical model should enhance our understanding of the mechanism of carbon trading price and volume of cap-and-trade system.

Persistence of Activist Short-Sellers’ Performance
Hu, Danqi,Walther, Beverly R.
We examine whether activists exhibit persistent cross-sectional performance differences in identifying targets to short. Although we find no evidence of performance persistence using target returns, we document that the target is more likely to delist if the activist had a greater percentage of past targets that delist. Investors recognize this persistent aspect of performance in reacting to the publication of short campaigns. Furthermore, we find that the performance persistence in identifying targets that delist is greater when activists are inexperienced, consistent with activists’ facing greater incentives to establish a reputation early in their careers.

Political Economy of the Euro Introduction in the Czech Republic
Helisek, Mojmir
The paper discusses two issues. Firstly: Can the euro also be introduced without an approval of the given country? The paper examines rules for adopting the euro comprised within various EU documents as well as existing experience of the euro area member states. The resulting answer is negative. Secondly: How can we describe the Czech strategy in adopting the euro? The negative position towards the euro is not motivated by economic reasons (nominal and real convergence to the euro area), but rather by political reasons arising in the past. This phenomenon can be described as “euro- hysteresis”.

Revisiting Covered Calls and Protective Puts: A Tale of Two Strategies
Foltice, Bryan
This paper examines the historical risk-adjusted returns of two hedging strategies designed to minimize downside market risk: Protective-puts and covered-calls, using US market data from 1993 to 2020. Here, we find that covered-call strategies significantly outperform the buy-and-hold strategy on a raw and risk-adjusted basis over the entire sample and these excess returns appear to remain persistent over time. We also find the opposite results hold for the protective put strategy: This strategy not only significantly underperforms the buy-and-hold strategy from a raw and risk-adjusted return standpoint, it actually significantly increases the probability of incurring losses each month. Finally, we evaluate the overall utility of various covered call strategies for loss averse investors, using the standard prospect theory utility function. Here, we find that out-of-the-money covered-call options yield the highest utilities for investors with less than average loss aversion, while in-the-money covered call options become more favorable as loss aversion increases.

Risks in Mergers and Acquisitions
Guo, Feng,Liu, Tingting,Shu, Tao,Yan, Xinyan
Using the risk-factor disclosure by bidders in merger filings, we study the composition of risks in M&As and the relations between major risks and important merger outcomes. We first find evidence that a bidder’s risk factor disclosure contains reliable information about risks in M&As. Next, we employ an unsupervised topic modeling approach to conduct textual analysis and identify specific topics of risk factor disclosure. We find that four risk factors, including technology and product, valuation and fairness, accounting information, and ownership and dilution, account for almost half of the bidder’s risk factor disclosure. Moreover, these major risk factors have strong and diverging relations with bidder’s post-merger outcomes including integration problems, volatilities of operating and stock performance, and levels of operating and stock performance.

Self-interest of Independent Directors and Liquidations of Mutual Funds
Zalewska, Anna (Ania),Zhang, Yue
Independent directors are appointed to represent the interests of mutual fund shareholders. Yet, being in the employment of fundâ€"families, the fulfilment of fiduciary duties of independent directors may be compromised. Using a large, hand-collected dataset of over 10,000 U.S. mutual funds, we analyze the impact of the degree of alignment of independent directors’ interests with those of shareholders as opposed to those of fundâ€"families on liquidation decisions. We find consistent evidence of our hypotheses that alignment with fundâ€"families dilutes the incentives imposed by the alignment with shareholders in retail funds. We also find consistent evidence that the alignment of independent directors with shareholders has positive effects only in institutional funds. These results have important policy implications which are discussed in the paper.

Signal-precision Uncertainty and Trading Volume
Armstrong, Chris,Heinle, Mirko Stanislav,Luneva, Irina
Traditional models of market reactions to signals about a firm's value predict that trading volume is a V-shaped function of the signal. These models also imply that investors' posterior beliefs converge after the signal is released. However, empirical and anecdotal evidence suggest that trading volume is not V-shaped and that investors' posterior beliefs seem to diverge following the release of certain types of information. We reconcile the conflicting theoretical predictions and empirical evidence by developing a generalized model in which investors have both heterogeneous beliefs about a firm's prospects and uncertainty about the signal-precision. In contrast to traditional models, we show that some signals cause investors' beliefs to diverge and trading volume, in turn, becomes an M-shaped function of the signal. We document empirical evidence that corroborates this prediction: we show that trading volume is indeed an M-shaped function. We also develop a measure of signal-precision uncertainty and show that trading volume's M-shaped pattern is more pronounced in an environment with high signal-precision uncertainty.

The Finances of Full-Time Employed Participants: With Canadian Financial Diaries Research Project, Phase One Participants
Buckland, Jerry,Nur, Wendy
This summary is the third in a series describing the financial health of low- and modest-middle income participants involved in the Canadian Financial Diaries Research Project. The seven participants in this summary were selected because they were all employed full-time. This summary aims to highlight for the reader the participants’ financial values and practices and to offer insights into participants’ financial wellbeing, including any barriers or opportunities which might impact their financial health or inform their financial decisions.

The Future of Payments in a DLT-based European Economy: A Roadmap
Bechtel, Alexander,Ferreira, Agata,Gross, Jonas,Sandner, Philipp G.
Distributed ledger technology (DLT) enables a wide range of innovative industrial use cases and business models, such as through programmable payments and the seamless exchange of assets, goods, and services. To exploit the full potential of a DLT-based European economy, it is crucial to integrate the euro into DLT networks. In this paper, we propose a framework for developing payment solutions for a DLT-based European economy. To this end, we decompose the digital payments value chain into three pillars: (1) contract execution system, (2) digital payment infrastructure, and (3) monetary unit. Based on this framework, we systematically compare account- and token-based payment solutions, including a bridge solution, e-money tokens, synthetic central bank digital currencies (CBDCs), and a central bank digital currency (CBDC). Taking into account current circumstances, we conclude that no individual payment solution will be sufficient to address all emerging use cases. Instead, a broad array of payment solutions will emerge and co-exist. These solutions will apply to a variety of different use cases and will be launched at different points in time.

The Informativeness of Internal Control Weakness Disclosure on Acquirers’ M&A Decisions
Yorke, Sally,Mo, Phyllis,Chan, Koon Hung
We examine the relevance of the disclosure of internal control weaknesses (ICWs) by target firms for acquirers in making their merger-and-acquisition (M&A) decisions. Based on a sample of M&A transactions in 2005â€"2018, we find that acquirers offer lower premiums for targets that disclose ICWs (ICW targets) before the acquisition, compared with targets that disclose no ICWs. This result is contrary to prior studies that rely on accrual quality and other proxies of targets’ information quality. We also find that acquirers offer less cash for ICW targets and that, also contrary to prior studies, ICW disclosure does not increase the probability of renegotiation on deals. The influence of ICW disclosure on premium and payment structure is more pronounced when acquirers and ICW targets are in different industries and when they do not share a common auditor. Overall, the results indicate that ICW disclosure by targets is informative to acquirers. We contribute to the literature by providing a comprehensive analysis on ICW and examining aspects of acquisitions not addressed in previous studies.

The Role of Fleeting Orders on Options Expiration
Figueiredo, Antonio,Jain, Pankaj K.,Mishra, Suchi
We employ NASDAQ order level data to analyze intraday trading at option expirations and cross-market price pressure spillover. Algorithmic traders appear to place proportionately more fleeting orders in optionable stocks on option expiration versus non-expiration days. Since most observed fleeting orders are outside the NBBO, we discard the possibility that their purpose is to search for latent liquidity. Relation between NBBO proximity to strike prices and fleeting order direction implies they play a role in stock price clustering on option expiration days. We show that fleeting orders impact subsequent NBBO and that fleeting order direction is related to option Open Interest.

The Use and Abuse of Non-GAAP Financial Measures: An Exploratory Study of Indian Companies
Narayanaswamy, R.
Indian companies use non-GAAP financial measures in addition to GAAP measures. Unlike GAAP measures, non-GAAP measures are not defined well. This creates conditions for managers to use these measures opportunistically to distort performance reporting and analysis. A relatively weak legal system and the absence of shareholder litigation in India make the abuse of these measures more likely than in developed countries. This study provides preliminary evidence based on annual reports for 187 firm-years for 54 firms about the use of non-GAAP measures in India. The evidence includes archival and anecdotal data. The evidence indicates that managers often use such measures opportunistically when faced with decline in sales or profit growth.

The initial deposit decision and the occurrence of bank runs
de Jong, Johan
In studies of bank runs the initial deposit decision is typically not taken into account. However, it is unlikely that people will entrust money to a bank that they expect to fail in the near future. The aim of this study is to investigate to what extent this mechanism prevents bank runs. It introduces an experiment in which participants first have to choose if they want to receive their endowments as a deposit in a `risky' bank that pays a high interest or a `safe' bank that pays a lower interest. After this decision they can withdraw the money from their account or leave it in to receive the interest. The availability of different deposit options leads to a very clear theoretical prediction: all choose to deposit in the risky bank with the high interest rate and consequently leave the deposit in the bank. In the experiment the first prediction is not confirmed: almost half of the participants choose to deposit in a safer alternative. However, in contrast to the control treatment in which participants are not offered a choice, only very few of those that choose the risky bank withdraw their deposits later.

The next step: Towards harmonised frameworks for the liquidation of non-systematically relevant credit institutions in the EU? A discussion of policy choices and potential impediments
Binder, Jens-Hinrich
As part of its ongoing consultation on the European crisis management and deposit insuranceframework currently available for the management of bank failures within the EU generallyand the Banking Union in particular, the European Commission has called for the respondents’views as to the need for further harmonisation of resolution arrangements for banks that currentlydo not qualify for resolution under the auspices of the Single Resolution Mechanism. In this respect, the consultation takes up a broader discussion on the need for harmonised bank insolvency regimes within the EU, which also ties in with an earlier international debate on the functional characteristics of optimal bank insolvency regimes initiated by international standardsetters in the early 2000s. Against this backdrop, the paper analyses the case for furtherreform, and identifies potential impediments (both technical and political) to be expected inthis regard. It argues that, while a full harmonisation of resolution powers and the centralisationof decision-making powers can be expected to address relevant concerns regarding thestatus quo, a comprehensive harmonisation can also be expected to meet with substantial politicalopposition, which in turn requires a better understanding of the functional requirementsto be met by less ambitious reforms.

Toil and Trouble, Don't Get Burned Shorting Bubbles
Brown, Aaron,Dewey, Richard
Bubbles are among the most puzzling and controversial phenomena of financial mar- kets. Although rare, their cumulative impact on both investor returns and the broader economy can be great. One particular question that has motivated research is why shrewd short sellers don’t prevent excessive price increases.The “limits to arbitrage” idea argues that correcting inefficient market prices is neither easy, cheap nor riskless. The “rational bubble” literature identifies situations in which being long the bubble is a better trade than being short, even if investors know for certain the bubble will pop. And there is a theory that bubbles only inflate after the shorts have suffered significant losses.We examine the “short subprime” trade from 2005 to 2008 to evaluate these and other explanations. We argue that the short subprime trades had more risk than is commonly appreciated. We discuss how the opaque and illiquid nature of subprime mortgages deterred some investors from purchasing CDS contracts and note that other investors assessed the risk of counterparty failure, government intervention and unknown time horizon to be sufficient enough not to purchase CDS contracts.In addition, we describe how factors such as performance convexity and credit convexity made the subprime short more profitable than most ex-ante calculations suggested. We also outline why the subprime short trade was ineffective at reining in the subprime bubble and how buying subprime after the crises was an equally, if not more attractive trade that potentially did more to mitigate the harm of the bubble. Looking back at the last major bubble with a decade of hindsight yields insights that might be helpful to market participants and policy makers thinking about future bubbles.

Utility Tokens Financing, Investment Incentives, and Regulation
Baranes, Edmond,Hege, Ulrich,Kim, Jin-Hyuk
We analyze a game-theoretic model, in which projects are financed by selling tokens that give access to consumption utility and the initial investors can sell their tokens in a secondary market. The efficiency of projects funded by token and equity financing is compared, and regulatory implications discussed. We then extent the model to consider the token issuer's ex-post investment incentive, which creates a gap between the size of funds raised and actual capital outlays. If the investors have a naive expectation, then the issuer can sometimes sell the entire token supply and invest nothing, so the project fails. If they have a rational expectation, then the equilibrium investment level becomes more efficient, but there can be still a room for regulatory policies such as setting a floor on the issuer's token holdings.

When Should There Be Vertical Choice in Health Insurance Markets?
Marone, Victoria,Sabety, Adrienne
We study the welfare effects of offering choice over coverage levelsâ€"â€"“vertical choice”â€"â€"in regulated health insurance markets. Though the efficient level of coverage, which trades off the value of risk protection and the social cost from moral hazard, likely varies across consumers, we emphasize that this variation alone is not sufficient to motivate choice. We show that vertical choice is efficient only if consumers with higher willingness to pay for insurance have a higher efficient level of coverage. Using administrative data from a large employer, we find that the welfare gains from vertical choice are either zero or economically small.

When the Walk is Not Random: Commodity Prices and Exchange Rates
Kohlscheen, Emanuel,Avalos, Fernando H.,Schrimpf, Andreas
We show that there is a distinct commodity-related driver of exchange rate movements, even at fairly high frequencies. Commodity prices predict exchange rate movements of eleven commodity-exporting countries in an in-sample panel setting for horizons up to two months. We also find evidence of systematic (pseudo) out-of-sample predictability, overturning the results of Meese and Rogoff (1983): information embedded in our country-specific commodity price indexes clearly helps to improve upon the predictive accuracy of the random walk in the majority of countries. We further show that the link between commodity prices and exchange rates is not driven by changes in global risk appetite or carry.

Why Are High Exposures to Factor Betas Unlikely to Deliver Anticipated Returns?
Brightman, Chris,Henslee, Forrest,Kalesnik, Vitali,Li, Feifei,Linnainmaa, Juhani T.
By choosing investment strategies that intentionally create exposure to factor betas, investors may be obtaining uncompensated risks. We show across a wide variety of factors and geographical markets that factors constructed from fundamental characteristics have earned high returns, whereas those constructed from statistical betas have earned returns close to zero. When designing factor-based investment strategies, investors should seek exposure to the fundamental characteristics that define a factor and use statistical measures of factor betas to manage factor risks. Conversely, seeking to gain exposure to factor betas is a misguided means of obtaining the returns available from factor investing.

Why Is Systematic Investing Important?
Harvey, Campbell R.
In this era of inexpensive computation and vast data, systematic, or algorithmically driven, investment is increasingly popular. Systematic strategies appear in stand-alone products as well in tail-hedging and defensive-overlay strategies. Indeed, given the enormous growth in data, it is becoming infeasible to process these data without the assistance of systematic tools. The key advantage of the systematic approach is the discipline it imposesâ€"for example, machines are not plagued by behavioral issues such as disposition bias, and in a time of crisis, a systematic strategy keeps a “cool head.” Systematic approaches also pose many challenges. Systematic strategies may not quickly adapt to structural changes in the market. They also present the risk of “tech-washing” whereby an investment product claims to use “the latest machine-learning tools,” but the tools are misapplied or play a minimal role. Importantly, when systematic tools are applied by an inexperienced researcher, the backtests are often overfit, leading to disappointing performance in live trading. Forthcoming, Journal of Systematic Investing, 2021.