Research articles for the 2021-04-07

Economics in Nouns and Verbs
W. Brian Arthur

Standard economic theory uses mathematics as its main means of understanding, and this brings clarity of reasoning and logical power. But there is a drawback: algebraic mathematics restricts economic modeling to what can be expressed only in quantitative nouns, and this forces theory to leave out matters to do with process, formation, adjustment, creation and nonequilibrium. For these we need a different means of understanding, one that allows verbs as well as nouns. Algorithmic expression is such a means. It allows verbs (processes) as well as nouns (objects and quantities). It allows fuller description in economics, and can include heterogeneity of agents, actions as well as objects, and realistic models of behavior in ill-defined situations. The world that algorithms reveal is action-based as well as object-based, organic, possibly ever-changing, and not fully knowable. But it is strangely and wonderfully alive.

Family Business â€" A Missing Link in Economics?
Johansson, Dan
Family firms account for a substantial share of economic activity and deviate from standard economic assumptions on firm behavior. However, little is known about how these firms are represented in economic theory. This article examines the inclusion of family business in the curricula of economics doctoral programs in the United States and Sweden as well as professors’ and textbook authors’ views and research on family business. Textbooks, articles and course offerings used in doctoral programs are considered to indicate the state of established knowledge in the field. The findings show that family business is not included in the examined curricula. Furthermore, professors and authors do not publish research on family business and generally do not see a need to incorporate it into economic theory. This article concludes that family business is excluded from ‘core’ economic theory due to a lack of paradigmatic pluralism, axiomatic incompatibility, path dependency, institutional bias and data constraints. Lastly, it is speculated that integration of family business theory into standard economic modeling is likely to occur outside prestigious universities due to path dependency in research

Hiring High-Skilled Labor through Mergers and Acquisitions
Chen, Jun,Hshieh, Shenje,Zhang, Feng
In two natural experiments based on H-1B visa lotteries and a drastic cut in the annual H-1B visa quota, we document that firms respond to shortages in high-skilled workers by acquiring target firms that have these workers. Additional tests show that desire for the target's skilled workers is an important driver of these acquisitions. Acquirers that successfully obtain skilled workers from their targets outperform acquirers that withdraw their acquisition bids for exogenous reasons. Our findings suggest that skilled labor is a driver of acquisition decisions and a source of synergy gains.

How Competitive is the Stock Market? Theory, Evidence from Portfolios, and Implications for the Rise of Passive Investing
Haddad, Valentin,Huebner, Paul,Loualiche, Erik
We develop a framework to theoretically and empirically analyze investor competition on financial markets. The classic view assumes that markets are very competitive: if a group of investors changes its behavior, other investors react such that nothing happens in equilibrium. Our framework quantifies the strength of the competitive response. We estimate a demand system of institutional investors in the US stock market accounting for two layers of equilibrium: how investors compete with each other in setting their strategies and how prices adjust to clear asset markets. We find that investors react to the behavior of others in the market: when an investor is surrounded by less aggressive traders she trades more aggressively. This reaction reduces the equilibrium consequences of changes in individual behavior by 50%. However, it also implies that the stock market is far from the competitive ideal. A consequence of this result is that the large increase in passive investing over the last 20 years has led to substantially more inelastic aggregate demand curves for individual stocks, by 15%.

Information Diffusion and Spillover Dynamics in Renewable Energy Markets
Cedic, Samir,Mahmoud, Alwan,Manera, Matteo,Uddin, Gazi Salah
The aim of this paper is to analyze the connectedness between renewable energy (RE) sectors, the oil & gas sector and other assets using time-scale spillover approach. We find that the RE bioenergy firms are the most connected to oil & gas firms and oil prices. The bond market transmits spillover to the RE sectors, while it receives spillover from the oil & gas sector. Moreover, short-run connectedness drives the dynamic total connectedness. Since changes in bond rates mainly spillover to RE firms and not to oil & gas firms, policy makers should also be aware that changes in interest rates may impact the societal transition to a RE based energy system. Since a shock that increases connectedness in the short run will deter investors from investing in RE assets, it is important for climate policy makers to develop policies that reduce the effect of increased connectedness on RE investments.

Investing in Polarized America: Real Economic Effects of Political Polarization
Zhu, Qiaoqiao
Political polarization, the ideological distance between the left and the right, is a defining feature of American politics. We study the link between rising polarization and firm investment. One standard deviation increase in roll-call-based polarization results in a reduction of 1% in firm investment, or 15% of the mean investment rate. The negative relation is robust to alternative the speech-based polarization measure and is most salient in inland firms. As a result, local employment and establishment suffer for border counties. We use geographical features to provide evidence of causality.

Investment Risk for Long-Term Investors
Warren, Geoff
Investment risk is addressed from the perspective of long-term investors, with key concepts being discussed and methods outlined for evaluating risk over long horizons. The main themes include: the need to focus on shortfall versus objectives and sources of sustained loss, rather than return volatility; the potential influence of path dependence; and the benefit of directly modelling the wealth accumulation process. A framework is presented that decomposes the drivers of wealth accumulation into initial expected returns, discount rate risk, cash flow risk and reinvestment risk. Approaches are highlighted for forming distributions of accumulated wealth, while demonstrating the importance of incorporating prevailing market conditions into any risk analysis. Alternatives to the Standard Risk Measure used for Australian superannuation funds are discussed.

Lockdown effects in US states: an artificial counterfactual approach
Carlos B. Carneiro,Iúri H. Ferreira,Marcelo C. Medeiros,Henrique F. Pires,Eduardo Zilberman

We adopt an artificial counterfactual approach to assess the impact of lockdowns on the short-run evolution of the number of cases and deaths in some US states. To do so, we explore the different timing in which US states adopted lockdown policies, and divide them among treated and control groups. For each treated state, we construct an artificial counterfactual. On average, and in the very short-run, the counterfactual accumulated number of cases would be two times larger if lockdown policies were not implemented.

Multiscale Governance
David Pastor-Escuredo,Philip Treleaven

Future societal systems will be characterized by heterogeneous human behaviors and also collective action. The interaction between local systems and global systems will be complex. Humandemics will propagate because of the pathways that connect the different systems and several invariant behaviors and patterns that have emerged globally. On the contrary, infodemics of misinformation can be a risk as it has occurred in the COVID-19 pandemic. The emerging fragility or robustness of the system will depend on how this complex network of systems is governed. Future societal systems will not be only multiscale in terms of the social dimension, but also in the temporality. Necessary and proper prevention and response systems based on complexity, ethic and multi-scale governance will be required. Real-time response systems are the basis for resilience to be the foundation of robust societies. A top-down approach led by Governmental organs for managing humandemics is not sufficient and may be only effective if policies are very restrictive and their efficacy depends not only in the measures implemented but also on the dynamics of the policies and the population perception and compliance. This top-down approach is even weaker if there is not national and international coordination. Coordinating top-down agencies with bottom-up constructs will be the design principle. Multi-scale governance integrates decision-making processes with signaling, sensing and leadership mechanisms to drive thriving societal systems with real-time sensitivity.

News Entropy
Kuhlen, Nikolas,Preston, Andrew
We introduce the concept of 'news entropy' to characterise the relationship between news coverage and the economy. Intuitively, news entropy decreases as the news focus on a smaller set of pressing topics. We observe that news entropy exhibits clear negative spikes close to important economic, financial, and political events. Investigating the effect of changes in news entropy, we find that decreases are associated with two key features: an increase in uncertainty measures and a macroeconomic contraction. The variable is priced in the cross-section of stock returns and low news entropy is associated with increased stock price volatility at the firm level.

Optimal Design of Tokenized Markets
Lee, Michael,Martin, Antoine,Townsend, Robert M.
Trades in today’s financial system are inherently subject to settlement uncertainty. This paper explores tokenization as a potential technological solution. A token system, by enabling programmability of assets, can be designed to eradicate settlement uncertainty. We study the allocations achieved in a decentralized market with either the legacy settlement system or a token system. Tokenization can improve efficiency in markets subject to a limited commitment problem. However, it also materially alters the information environment, which in turn aggravates a hold-up problem. This limits potential gains from resolving settlement uncertainty, particularly for marketsthat depend on intermediaries.

Partisan Entrepreneurship
Engelberg, Joseph,Guzman, Jorge,Lu, Runjing,Mullins, William
Republicans start more firms than Democrats. Using a sample of 27 million party-identified Americans between 1997 and 2017, we find that 9\% of Republicans and 6\% of Democrats become entrepreneurs. This partisan entrepreneurship gap is time-varying: Republicans increase their relative entrepreneurship during Republican administrations and decrease it during Democratic administrations, with sharp changes around the elections of President Obama and President Trump. The strongest effects exist among the most politically active partisans: those that donate and vote.

Pricing Climate Change Risk in Corporate Bonds
Allman, Elsa
Using a firm’s geographic footprint to measure its exposure to sea level rise (SLR), I find that corporate bonds bear a climate risk premium upon issuance. A one standard deviation increase in firms’ SLR exposure is associated with a 7 basis point premium, representing a 3% increase in average yield spread. This effect is more pronounced for geographically concentrated firms, within industries vulnerable to extreme weather conditions, and after the Paris Agreement. I do not find evidence that credit rating agencies account for SLR exposure at bond issuance. Results are robust to placebo tests and inverse propensity weighting to address possible endogeneity.

Racial Disparities in Small Business Lending
Chen, Tao,Lin, Chen,Sun, Bo
Institutional racism can manifest itself in banking relationships in generational ways. In this article, we study the magnitude and origins of racial disparities in the U.S. small business credit market. Exploiting a unique dataset containing rich loan contract information, including firm and lender characteristics, we document sizable racial differentials in small business lending, measured by loan denial rates and interest rates between Black-owned businesses and otherwise observationally identical non-minority-owned businesses. Such racial disparities are most pronounced in areas associated with severe racial bias against African Americans. Crucially, we show that, consistent with Becker (1957) theory of taste-based discrimination, an exogenous intensification of credit competition has a quantitatively large effect in reducing racial disparities in small business lending. Our findings shed new light on the origins of racial disparities in small business credit markets, pointing to institutional racism that could foreshadow long-term ramifications for racial inequality.

Secured Transactions Law Reform in Japan: Japan Business Credit Project Assessment of Interviews and Tentative Policy Proposals
Hara, Megumi,Koens, Kumiko,Mooney, Charles W.
This article summarizes key findings from the Japan Business Credit Project (JBCP), which involved more than 30 semi-structured interviews conducted in Japan from 2016 through 2018. It was inspired by important and previously unexplored questions concerning secured financing of movables (business equipment and inventory) and claims (receivables)â€"“asset-based lending” or “ABL.” Why is the use of ABL in Japan so limited? What are the principal obstacles and disincentives to the use of ABL in Japan? The interviews were primarily with staff of banks, but also included those of government officials and regulators, academics, and law practitioners. The article proposes reforms of Japanese secured transactions law that would address several prevailing problems with ABL. The reforms would move Japanese law toward the modern principles that are epitomized by Article 9 of the UCC in the United States and the UNCITRAL Model Law on Secured Transactions. These proposals also could materially improve Japan’s standings in the World Bank Group Doing Business Rankings.Three committees with government connections recently have been studying secured transactions law reforms in Japan. We expect that the government will move to a more formal stage of considering reforms in the near future. We are optimistic that the article will be influential on the substance and ultimate enactment of law reforms. Our research illuminates the stark contrast between the situation in Japan and the modern principles of secured transactions law embodied in the UNCITRAL Model Law, which is designed to enhance access to credit through ABL. Finally, the article identifies important new insights for secured transactions law reforms, not only in Japan but in other jurisdictions. These insights are illuminating as well for future business law reforms more generally. In particular, the article explains the value and utility of qualitative empirical research such as the JBCP for the process of law reform.

The Future of Disclosure: ESG, Common Ownership, and Systematic Risk
Coffee, John C.
The U.S. securities markets have recently undergone (or are undergoing) three fundamental transitions: (1) institutionalization (with the result that institutional investors now dominate both trading and stock ownership); (2) extraordinary ownership concentration (with the consequence that the three largest U.S. institutional investors now hold 20% and vote 25% of the shares in S&P 500 companies); and (3) the introduction of ESG disclosures (which process has been driven in the U.S. by pressure from large institutional investors). In light of these transitions, how should disclosure policy change? Do institutions and retail investors have the same or different disclosure needs? Why are large institutions pressing for increased ESG disclosures? This article will focus on the desire of institutions for greater ESG disclosures and suggest that two reasons underlie this demand for more information: (1) ESG disclosures overlap substantially with systematic risk, which is the primary concern of diversified investors; and (2) high common ownership enables institutions to take collective action to curb externalities caused by portfolio firms, so long as the gains to their portfolio from such action exceed the losses caused to the externality-creating firms. This transition to a portfolio-wide perspective (both in voting and investment decisions) has significant implications but also is likely to provoke political controversy. In its final hours, the Trump Administration adopted new rules that discourage voting based on ESG criteria and thus by extension chill ESG investing. This controversy will continue.As more institutions shift to portfolio-wide decision making, there is an optimistic upside: externalities may be curbed by collective shareholder action. For entirely rational reasons, the new “universal” shareholders who now dominate the market will resist even large public companies who might seek to impose externalities on other companies. Owning the market, the “universal” shareholder will protect the market. Still, this process of resistance may produce frictions, and the disclosure needs of individual investors and institutional investors will increasingly diverge. Of course, not all institutional investors are indexed or even diversified, but those that remain undiversified (for example, hedge funds) logically have the perspective of an option-holder and favor greater risk-taking. Across the board, retail investors have different perspectives and preferences than do institutional investors.Above all, the combination of high common ownership and institutional sensitivity to systematic risk makes disclosure a far more powerful force. Once a very good disinfectant, it may now be developing a laser-like power to effect significant social change.

The Marginal Profit-to-Q Ratio: Reassessing the Cash-Flow Channel
Maio, Paulo F.,Cooper, Ilan,Yang, Chunyu
We study a production-based present-value relation that implies that fluctuations in the marginal profit-to-marginal Q ratio (mq) are driven by variations in the expected growth of marginal profits (cash-flow channel), expected investment return changes (discount-rate channel), or both. We find that in contrast to the aggregate dividend-to-price ratio, mq strongly predicts marginal profits growth at both short and long horizons, but not investment returns. mq also predicts (negatively) the growth rates of aggregate earnings, industrial production, and non-farm payrolls. Our findings can guide modeling in which the expected growth rate of marginal profits (at multiple horizons) is time-varying.

The Voice of Monetary Policy
Gorodnichenko, Yuriy,Pham, Tho,Talavera, Oleksandr
We develop a deep learning model to detect emotions embedded in press conferences after the meetings of the Federal Open Market Committee and examine the influence of the detected emotions on financial markets. We find that, after controlling for the Fed’s actions and the sentiment in policy texts, positive tone in the voices of Fed Chairs leads to statistically significant and economically large increases in share prices. In other words, how policy messages are communicated can move the stock market. In contrast, the bond market appears to take few vocal cues from the Chairs. Our results provide implications for improving the effectiveness of central bank communications.

The value of big data for analyzing growth dynamics of technology based new ventures
Maksim Malyy,Zeljko Tekic,Tatiana Podladchikova

This study demonstrates that web-search traffic information, in particular, Google Trends data, is a credible novel source of high-quality and easy-to-access data for analyzing technology-based new ventures (TBNVs) growth trajectories. Utilizing the diverse sample of 241 US-based TBNVs, we comparatively analyze the relationship between companies' evolution curves represented by search activity on the one hand and by valuations achieved through rounds of venture investments on another. The results suggest that TBNV's growth dynamics are positively and strongly correlated with its web search traffic across the sample. This correlation is more robust when a company is a) more successful (in terms of valuation achieved) - especially if it is a "unicorn"; b) consumer-oriented (i.e., b2c); and 3) develops products in the form of a digital platform. Further analysis based on fuzzy-set Qualitative Comparative Analysis (fsQCA) shows that for the most successful companies ("unicorns") and consumer-oriented digital platforms (i.e., b2c digital platform companies) proposed approach may be extremely reliable, while for other high-growth TBNVs it is useful for analyzing their growth dynamics, albeit to a more limited degree. The proposed methodological approach opens a wide range of possibilities for analyzing, researching and predicting the growth of recently formed growth-oriented companies, in practice and academia.

Towards an optimal composition of bail-inable debtholders?
Martino, Edoardo D.
The core insight of the new EU framework for bank resolution is to allocate losses to bank’s insiders (bail-inable creditors). This affects both financial stability and the corporate governance of banks. The current academic debate on bank resolution overlooks the relevance of identifying the investors in bail-inable securities (ie who is going to bear losses) and the role of counterparty risk. This article identifies the investors that are better suited to hold those instruments and highlights the trade-offs between the corporate governance role and the threat to financial stability posed bydifferent investors. The article demonstrates that the composition of bailinable debtholders matters and shows â€" empirically and theoretically â€" a transition towards a desirable composition of holders; although a considerable room for improvement remains. This exercise deepens the understanding of the impact of the resolution framework and the importance of counterparties for its credibility and future applications.

Unraveling S&P500 stock volatility and networks -- An encoding-and-decoding approach
Xiaodong Wang,Fushing Hsieh

Volatility of financial stock is referring to the degree of uncertainty or risk embedded within a stock's dynamics. Such risk has been received huge amounts of attention from diverse financial researchers. By following the concept of regime-switching model, we proposed a non-parametric approach, named encoding-and-decoding, to discover multiple volatility states embedded within a discrete time series of stock returns. The encoding is performed across the entire span of temporal time points for relatively extreme events with respect to a chosen quantile-based threshold. As such the return time series is transformed into Bernoulli-variable processes. In the decoding phase, we computationally seek for locations of change points via estimations based on a new searching algorithm conjunction to the Bayesian information criterion applied on the observed collection of recurrence times upon the binary process. Besides the independence required for building the Geometric distributional likelihood function, the proposed approach can functionally partition the entire return time series into a collection of homogeneous segments without any assumptions of dynamic structure and underlying distributions. In the numerical experiments, our approach is found favorably compared with Viterbi's under Hidden Markov Model (HMM) settings. In the real data applications, volatility dynamics of every single stock of S&P500 are computed and revealed. Then, a non-linear dependency of any stock-pair is derived by measuring through concurrent volatility states. Finally, various networks dealing with distinct financial implications are consequently established to represent different aspects of global connectivity among all stocks in S&P500.

Window dressing systemic importance: evidence from EU banks and the G-SIB framework
Garcia, Luis,Lewrick, Ulf,Sečnik, Taja
Building on previous research, we study banks’ balance sheet year-end patterns in the European Union (EU) to assess the impact on supervisory measures of their systemic importance. We find that some global systemically important banks (G-SIBs) in the EU compress their balance sheet at year-end to an extent that it allows them to reduce their systemic importance, thus potentially mitigating the impact of the G-SIB capital surcharges or avoiding G-SIB designation altogether. Since some year-end adjustments are a common feature, we compare G-SIBs’ adjustments to those of other systemically important institutions (O-SIIs) and observe that the compression of the latter banks’ balance sheets is notably smaller. G-SIBs’ balance sheets adjustments reflect several drivers, with the most notable year-end declines observed for intra-financial assets and liabilities as well as banks’ notional amounts of over-the-counter derivatives. Reduction is most pronounced for G-SIBs characterised by comparatively high leverage. This evidence of possible window dressing underscores the importance of supervisory judgement in the assessment of G-SIBs, which is indeed a core component of the identification process. We also suggest greater use of average as opposed to point-in-time data in the quantitative part of the G-SIB identification process.

Zero Settlement Risk Token Systems
Lee, Michael,Martin, Antoine,Townsend, Robert M.
How might a modern settlement system with distributed ledger technology achieve zero settlement risk? We consider the design of a settlement system based that satisfies two integral features: information-leakage proof and zero settlement risk. The legacy settlement systems partition market participants’ private information but are vulnerable to settlement risk. We show that a token system can be designed to achieve both as long it employs a protocol that enforces appropriate restrictions on the set of programs traders can enter. First, programs must be immediately executed, i.e. a collapse between trade and settlement; second, they must also involve transactions based on verifiable claims, at the time of trade. We provide concrete applications of zero settlement risk system to derivatives, collateralized loans, and securitization.