Research articles for the 2021-05-07

A Market Microstructure View of the Informational Efficiency of Security Prices
Schwartz, Robert
Do equity prices efficiently reflect fundamental information as the Efficient Markets Hypothesis suggests? The author challenges a widely held acceptance by financial academicians of the EMH. In a frictionless environment, information acquisition and trading would be costless, transaction prices would reflect information perfectly, prices would follow random walks, and the EMH would be validated. But markets are not frictionless. The assumption is commonly invoked in academic research that informed investors have homogeneous expectations. But, given the enormity and complexity of information sets, investor expectations differ. Taking an intraday, microstructure focus, the author explains that price discovery in a non-frictionless, divergent expectations environment is a protracted, dynamic process that accentuates intra-day price volatility and introduces return autocorrelations. This counters the EMH. He stresses the importance of instituting a market structure that further enhances the operational and therefore informational efficiency of a security market.

Asset Market Liquidity Risk Management Using Machine Learning Techniques
Al Janabi, Mazin A. M.
Asset market liquidity risk is a significant and perplexing subject and though the term market liquidity risk is used quite chronically in academic literature it lacks an unambiguous definition, let alone understanding of the proposed risk measures. To this end, this paper presents a review of contemporary thoughts and attempts vis-à-vis asset market/liquidity risk management. Furthermore, this research focuses on the theoretical aspects of asset liquidity risk and presents critically two reciprocal approaches to measuring market liquidity risk for individual trading securities, and discusses the problems that arise in attempting to quantify asset market liquidity risk at a portfolio level. This paper extends research literature related to the assessment of asset market/liquidity risk by providing a generalized theoretical modeling underpinning that handle, from the same perspective, market and liquidity risks jointly and integrate both risks into a portfolio setting without a commensurate increase of statistical postulations. As such, we argue that market and liquidity risk components are correlated in most cases and can be integrated into one single market/liquidity framework that consists of two interrelated sub-components. The first component is attributed to the impact of adverse price movements, while the second component focuses on the risk of variation in transactions costs due to bid-ask spreads and it attempts to measure the likelihood that it will cost more than expected to liquidate the asset position. We thereafter propose a concrete theoretical foundation and a new modeling framework that attempts to tackle the issue of market/liquidity risk at a portfolio level by combining two asset market/liquidity risk models. The first model is a re-engineered and robust liquidity horizon multiplier that can aid in producing realistic asset market liquidity losses during the unwinding period. The essence of the model is based on the concept of Liquidity-Adjusted Value-at-Risk (L-VaR) framework, and particularly from the perspective of trading portfolios that have both long and short trading positions. Conversely, the second model is related to the transactions cost of liquidation due to bid-ask spreads and includes an improved technique that tackles the issue of bid-ask spread volatility. As such, the model comprises a new approach to contemplating the impact of time-varying volatility of the bid-ask spread and its upshot on the overall asset market/liquidity risk using machine learning techniques.

Bank Relationships and the Geography of PPP Lending
Glancy, David
I use geocoded data on Paycheck Protection Program (PPP) loans to investigate the spatial distribution of PPP originations. I document three findings. First, 60% of bank loans come from banks with branches within 2 miles of the borrower. Second, borrowers using a nearby bank get credit sooner, particularly if the bank is a more active PPP participant. Third, census tracts where nearby banks are less active PPP lenders receive funding later and receive less funding overall, though increased lending from Fintechs offset much of the decline in credit. The results highlight that despite PPP loans being fully-guaranteed, there were still significant frictions in substituting away from relationship lenders.

Competitive Pressure and Firm Investment Efficiency: Evidence from Corporate Employment Decisions
Boubaker, Sabri,Dang, Viet Anh,Sassi, Syrine
This study examines the link between product market competition and labor investment efficiency. We find that competitive pressure distorts the efficiency of corporate employment decisions by creating an underinvestment problem. This finding withstands a battery of robustness checks and remains unchanged after accounting for endogeneity concerns. Additional analysis shows that the relation between product market competition and labor investment efficiency is stronger for firms facing higher competitive threats, greater financial constraints, higher information asymmetry, and higher labor adjustment costs. Our results suggest that since competition increases bankruptcy risk, it leads managers to underinvest in labor to avoid incurring labor-related costs.

Country Risk
Hassan, Tarek A.,Schreger, Jesse,Schwedeler, Markus,Tahoun, Ahmed
We construct new measures of country risk and sentiment as perceived by global investors and executives using textual analysis of the quarterly earnings calls of publicly listed firms around the world. Our quarterly measures cover 45 countries from 2002-2020. We use our measures to provide a novel characterization of country risk and to provide a harmonized definition of crises. We demonstrate that elevated perceptions of a country's riskiness are associated with significant falls in local asset prices and capital outflows, even after global financial conditions are controlled for. Increases in country risk are associated with reductions in firm-level investment and employment. We also show direct evidence of a novel type of contagion, where foreign risk is transmitted across borders through firm-level exposures. Exposed firms suffer falling market valuations and significantly retrench their hiring and investment in response to crises abroad. Finally, we provide direct evidence that heterogeneous currency loadings on global risk help explain the cross-country pattern of interest rates and currency risk premia.

E-money, Credit Cards, and Privacy
Kang, Kee-Youn
We develop a monetary model where the monopoly company issues E-money and uses payment data to estimate consumers' preferences. Sellers purchase the preference information to produce goods that better match consumers' preferences. Due to reinforcing interactions between the value of the preference information and the trade volume, multiple equilibria --- with and without E-money --- can exist. Introducing central bank digital currency with the optimal privacy design improves welfare and restores the optimality of the Friedman rule. The company achieves lower profits from issuing credit cards than issuing E-money. However, welfare is higher when consumers use credit cards rather than E-money.

Liquidity Risk Management: Structural Issues, Behavioural Biases, and Managerial Myopia
Srivastava, Dr Ashish
The likelihood of not getting the desired funding at an appropriate cost or the probability of an undue loss of value in the event of a fire sale of assets is recognised as the liquidity risk. Moreover, a flat idiosyncratic liquidity risk does not necessarily translate into a similar risk neutral position at the systemic level. Hence, adoption of perfectly rational liquidity management policies at the institutional level may not necessarily protect a financial institution from the ill-effects of systemic liquidity imbalances. To compound the imbroglio, perceptions and approaches towards any impending liquidity risk are often found to be shrouded in failure to recognise such risks and also in attempts to derecognise such risks on account of certain behavioural biases such as overconfidence, linear extrapolation, confirmation bias, and groupthink. Effective liquidity risk management therefore, requires not only a clear understanding of the tenets of finance but also needs conscious efforts for mitigation of the behavioural biases and managerial myopia. This paper presents an overview of liquidity risk management in the context of the urban cooperative banks with special focus on the behavioural dimensions of risk.

Market Failures in Market-Based Finance
di Iasio, Giovanni,Kryczka, Dominika
We build a three-period model to investigate market failures in the market-based financial system. Institutional investors (IIs), such as insurance companies and pension funds, have liabilities offering guaranteed returns and operate under a risk-sensitive solvency constraint. They seek to allocate funds to asset managers (AMs) that provide diversification when investing in risky assets. At the interim date, AMs that run investment funds face investor redemptions and liquidate risky assets and/or deplete cash holdings, if available. Dealer banks can purchase risky assets, thus providing market liquidity. The latter ultimately determines equilibrium allocations. In the competitive equilibrium, AMs suffer from a pecuniary externality and hold inefficiently low amounts of cash. Asset fire sales increase the overall cost of meeting redemptions and depress risk-adjusted returns delivered by AMs to IIs, forcing the latter to de-risk. We show that a macroprudential approach to (i) the liquidity regulation of AMs and (ii) the solvency regulation of IIs can improve upon the competitive equilibrium allocations.

Network-Induced Agency Conflicts in Delegated Portfolio Management
Gao, Xinzi,Wong, T.J.,Xia, Lijun,Yu, Gwen
Social ties between mutual funds and the companies in which they invest (investees) can both facilitate information transfers and encourage favoritism. Using the investment choices of mutual funds in China, we compare investment performance of holdings in companies that are socially connected to mutual funds versus those that are not. We find that funds allocate more investment to connected investees’ stocks, especially when a fund is weakly monitored. This overweighting is greater in times of poor investee performance, when the benefits of additional investment to the connected investees are high. Weakly monitored funds’ preference for connected stocks hurts the returns of these funds, yielding a 6.6% lower annualized risk-adjusted return, relative to closely monitored funds. These results suggest that, absent sufficient monitoring, agency conflicts generated by social networks can dominate the information advantages of these networks.

Risk Reporting in the German Insurance Industry: An Empirical Investigation of Group Management Reports (Risikoberichterstattung in der deutschen Versicherungswirtschaft: Eine empirische Untersuchung von Konzernlageberichten)
Dobler, Michael,Schwartze, Felix
English Abstract: This paper is the first to investigate the characteristics and determinants of risk reporting volume and quality by German insurance companies in group management reports under the German Accounting Standard No. 20 (GAS 20) “Group Management Report”. We find heterogeneous risk reporting practices in terms of volume and quality. Despite considerable volume, actual risk disclosures seem to leave room for improvement given the disclosure items listed in GAS 20. Beyond a size-effect, we document diverse factors relating to risk reporting volume and quality. Consistent with Dobler (2008), risk reporting by German insurance companies seems to depend on disclosure incentives despite detailed disclosure regulations in place. Our findings yield implications relevant to practice, regulation, and research in the field of risk reporting by insurance companies.German Abstract: Dieser Beitrag untersucht erstmals empirisch die Ausgestaltung und die Determinanten der Risikoberichterstattung von deutschen Versicherungsunternehmen in den obligatorischen Konzernlageberichten nach dem Deutschen Rechnungslegungs Standard Nr. 20 (DRS 20) „Konzernlagebericht“ hinsichtlich ihres Umfangs und ihrer Güte. Die Risikoberichterstattungspraxis erweist sich als heterogen und bleibt trotz beträchtlichem Umfang oft hinter den von DRS 20 vorgesehenen Angaben zurück. Über einen üblichen Size-Effekt hinaus scheinen Umfang und Güte der Risikoberichterstattung von diversen unternehmensspezifischen Einflussfaktoren geprägt zu sein. Wie branchenunabhängig von Dobler (2008) postuliert, erweist sich die Risikoberichterstattungspraxis deutscher Versicherungsunternehmen, trotz ausgeprägter Regulierung, von Publizitätsanreizen getrieben. Die Befunde bergen Implikationen für die Praxis, Regulierung und Forschung im Feld der branchenspezifischen Risikoberichterstattung.

Ten Million or One Hundred Million Casualties? â€" The Impact of the COVID-19 Crisis on the Least Developed and Developing Countries and Europe’s Sustainability Agenda
Zetzsche, Dirk A.,Consiglio, Roberta
This is an updated version of the working paper 2020-008 of 02/10/2020.This chapter argues that the overall impact of the COVID-19 crisis on developing countries is massive, with a potentially very high number of casualties: we float an entirely arbitrary figure of 100 million. To arrive at this number, we collect and collate the different ways in which COVID-19 may hit low- and middle-income countries from a public health perspective as well as economically, and show that the crisis may not only threaten many people’s lives but may even reverse the positive development trend of the last 20 years, putting the realization of the United Nation’s Sustainable Development Goals in some doubt. We further show that the response by EU and European countries as well as the world community is unfit to address this calamity. In turn, we propose five policy measures to mitigate the most severe impacts of the crisis on the least developed and developing countries. The chapter is structured as follows: Part 1 provides the context. Part 2 argues that the number of COVID19 cases and casualties in the least developed and developing countries is almost certainly underestimated and understated. Part 3 lays out the indirect severe impacts of the crisis, namely the inevitable return of hunger and famine to many parts of the world. Part 4 suggests that the abandonment of the UN’s SDGs is one likely effect of the crisis in the absence of coordinated efforts; and Part 5 argues that the global and European support is insufficient to reverse the trend, indicating a departure from, or at least delay of, the sustainability agenda a possible, if not likely scenario. Part 6 presents five policy principles designed to limit the looming human tragedy. Part 7 concludes.

The Non-Linear Relationship between Financial Access and Domestic Savings: The Case of Emerging Markets
Emara, Noha,KASA, Öğr . Üyesi Hicran
This paper examines the impact of financial access on the accumulation of domestic savings in emerging markets (EMs) covering countries from Latin America, Europe, Middle East, and Africa (EMEA), and Asia as classified by the Morgan Stanley Capital International (MSCI) index. We use the System Generalized Method of Moments panel estimation methodology on annual data spanning the period 1980-2018. Principal component analysis allows us to create a financial access index as a linear combination of two variables measured per 100,000 adults: number of bank branches per and number of ATMs. The results of the paper reveal a statistically significant nonlinear relationship between the improvement in financial access measures and the accumulation of domestic savings with a definite threshold level. More specifically, our results for the full sample indicate that improvement in financial access may initially increase the savings rate leading to an increase in savings. Nevertheless, once the financial access index reaches its threshold level further improvement in financial access tends decrease households’ precautionary savings and to give rise to a decline in savings. Thus, the duality of the pattern highlights the non-linearity of financial access and domestic savings.

The Social Issue of ESG Analysis
Semet, Raphaël
This report studies the social issue of ESG analysis and the multi-faceted approaches of measuring and assessing the social dimension. After reviewing the huge array of literature on social inequalities, our analysis focuses on the main "social pillars", which include economic, health, gender and education aspects as the predictors of structural inequality. Moreover, we compare the social risk with the environmental risk to emphasize their relative interconnectedness. An important challenge concerns the measurement puzzle of the social pillars, since there are many conceptual and empirical metrics to measure the social risk at country and corporate levels. Nevertheless, we observe an existing gap between the two fields of analysis, implying that some coherency differences may exist between macro-economic and micro-economic approaches of social welfare analysis. Finally, the last section of this report is dedicated to the quantitative analysis of the impact of social inequalities on government bond yield spread. In particular, we test four social variables: (1) Gini index of income inequality, (2) universal health coverage, (3) women's economic participation and opportunity, and (4) access to primary education. Using a panel regression model, we found a statistically significant relationship between the Gini index and the cost of borrowing of OECD members between 2015 and 2018. The relationship is no more significant once sovereign credit ratings are included in the regression though. From this result, we split the analysis between the investment grade (IG) category and the high yield (HY) category. We finally confirm the relationship between the two variables for the IG sovereign bond category while we cannot conclude on the relationship regarding the HY category. Overall, the social variables related to the health, gender and education aspect of the S pillar are not integrated in sovereign ESG, either in the pricing of the sovereign bonds or in the monitoring of the sovereign risk.

What Moves the Market? Individual Firms’ Earnings Announcements Versus Macro Releases As Drivers of Index Returns
Ogneva, Maria,Xia, Jingjing
In this paper, we characterize the relative importance of two sources of fundamental market-wide newsâ€"large firms’ earnings announcements and macroeconomic releases. Our investigation is motivated by growing concerns in the financial community about the increasing impact of individual firms’ news on the broad stock market indices and the disconnect between the stock market and the economy at large. We leverage the S&P500 index futures data and use narrow intraday and overnight windows to isolate the market-wide reactions to earnings and macro announcements. We find that earnings announcements represent an economically significant source of index-level market activityâ€"an average earnings announcement experiences around 21% (47%) of abnormal volatility (trading volume) associated with an average macroeconomic release. The returns earned over earnings announcement windows serve as a significant driver of daily index price movement. Importantly, earnings announcements’ contribution to index-level volatility has been relatively stable over our sample period from 2004 to 2018, while we observe a drastic decrease in the volatility explained by macro announcements. The latter is consistent with a growing disconnect between the stock market and the broader macroeconomy.