# Research articles for the 2021-05-30

A Note on Optimal Fees for Constant Function Market Makers
Robin Fritsch,Roger Wattenhofer
arXiv

We suggest a framework to determine optimal trading fees for constant function market makers (CFMMs) in order to maximize liquidity provider returns. In a setting of multiple competing liquidity pools, we show that no race to the bottom occurs, but instead pure Nash equilibria of optimal fees exist. We theoretically prove the existence of these equilibria for pools using the constant product trade function used in popular CFMMs like Uniswap. We also numerically compute the equilibria for a number of examples and discuss the effects the equilibrium fees have on capital allocation among pools. Finally, we use our framework to compute optimal fees for real world pools using past trade data.

Behavior of Liquidity Providers in Decentralized Exchanges
Ye Wang,Lioba Heimbach,Roger Wattenhofer
arXiv

Decentralized exchanges (DEXes) have introduced an innovative trading mechanism, where it is not necessary to match buy-orders and sell-orders to execute a trade. DEXes execute each trade individually, and the exchange rate is automatically determined by the ratio of assets reserved in the market. Therefore, apart from trading, financial players can also liquidity providers, benefiting from transaction fees from trades executed in DEXes. Although liquidity providers are essential for the functionality of DEXes, it is not clear how liquidity providers behave in such markets.In this paper, we aim to understand how liquidity providers react to market information and how they benefit from providing liquidity in DEXes. We measure the operations of liquidity providers on Uniswap and analyze how they determine their investment strategy based on market changes. We also reveal their returns and risks of investments in different trading pair categories, i.e., stable pairs, normal pairs, and exotic pairs. Further, we investigate the movement of liquidity between trading pools. To the best of our knowledge, this is the first work that systematically studies the behavior of liquidity providers in DEXes.

Blending Advertising with Organic Content in E-Commerce: A Virtual Bids Optimization Approach
Carlos Carrion,Zenan Wang,Harikesh Nair,Xianghong Luo,Yulin Lei,Xiliang Lin,Wenlong Chen,Qiyu Hu,Changping Peng,Yongjun Bao,Weipeng Yan
arXiv

Cybersecurity and Sustainable Development
Adam Sulich,Malgorzata Rutkowska,Agnieszka Krawczyk-Jezierska,Jaroslaw Jezierski,Tomasz Zema
arXiv

Growing interdependencies between organizations lead them towards the creation of inter-organizational networks where cybersecurity and sustainable development have become one of the most important issues. The Environmental Goods and Services Sector (EGSS) is one of the fastest developing sectors of the economy fueled by the growing relationships between network entities based on ICT usage. In this sector, Green Cybersecurity is an emerging issue because it secures processes related directly and indirectly to environmental management and protection. In the future, the multidimensional development of the EGSS can help European Union to overcome the upcoming crises. At the same time, computer technologies and cybersecurity can contribute to the implementation of the concept of sustainable development. The development of environmental technologies along with their cybersecurity is one of the aims of the realization of sustainable production and domestic security concepts among the EU countries. Hence, the aim of this article is a theoretical discussion and research on the relationships between cybersecurity and sustainable development in inter-organizational networks. Therefore, the article is an attempt to give an answer to the question about the current state of the implementation of cybersecurity in relation to the EGSS part of the economy in different EU countries.

Does a Financial Crisis Change a Bank&Apos;S Exposure to Risk? A Difference-in-Differences Approach
Angelidis, Timotheos,Benos, Alexander,Degiannakis, Stavros Antonios,Schweiger, Helena
SSRN
Can a major financial crisis trigger changes in a bankâ€™s risk-taking behavior? Using the 2008 Global Financial Crisis as a quasi-natural experiment and a difference-in-differences approach, I examine whether the worst crisis-hit Russian banks â€" the banks that have strong incentives to behavior-altering changes â€" can decrease their post-crisis exposure to risk. A shift in risk-taking behavior by these banks indicates the learning hypothesis. The findings are mixed. The evidence concerning credit risk is inconsistent with the learning hypothesis. On the other hand, the evidence concerning solvency risk is consistent with the learning hypothesis and corroborates evidence from the Nordic countries (Berglund and MÃ¤kinen, 2019). As such, bank learning from a financial crisis may not depend on the institutional context and the level of development of national financial market. Several robustness checks with alternative regression specifications are provided.

Incorporating prior financial domain knowledge into neural networks for implied volatility surface prediction
Yu Zheng,Yongxin Yang,Bowei Chen
arXiv

In this paper we develop a novel neural network model for predicting implied volatility surface. Prior financial domain knowledge is taken into account. A new activation function that incorporates volatility smile is proposed, which is used for the hidden nodes that process the underlying asset price. In addition, financial conditions, such as the absence of arbitrage, the boundaries and the asymptotic slope, are embedded into the loss function. This is one of the very first studies which discuss a methodological framework that incorporates prior financial domain knowledge into neural network architecture design and model training. The proposed model outperforms the benchmarked models with the option data on the S&P 500 index over 20 years. More importantly, the domain knowledge is satisfied empirically, showing the model is consistent with the existing financial theories and conditions related to implied volatility surface.

Xiao Chen,Jin Hyuk Choi,Kasper Larsen,Duane J. Seppi
arXiv

This paper presents an equilibrium model of dynamic trading, learning, and pricing by strategic investors with trading targets and price impact. Since trading targets are private, rebalancers and liquidity providers filter the child order flow over time to estimate the latent underlying parent trading demand imbalance and its expected impact on subsequent price pressure dynamics. We prove existence of the equilibrium and solve for equilibrium trading strategies and prices in terms of the solution to a system of coupled ODEs. We show that trading strategies are combinations of trading towards investor targets, liquidity provision for other investors' demands, and front-running based on learning about latent underlying trading demand imbalances and future price pressure.

No COVID-19 Climate Silver Lining in the US Power Sector
Max Luke,Priyanshi Somani,Turner Cotterman,Dhruv Suri,Stephen J. Lee
arXiv

Recent studies conclude that the global coronavirus (COVID-19) pandemic decreased power sector CO$_2$ emissions globally and in the United States. In this paper, we analyze the statistical significance of CO2 emissions reductions in the U.S. power sector from March through December 2020. We use Gaussian process (GP) regression to assess whether CO2 emissions reductions would have occurred with reasonable probability in the absence of COVID-19 considering uncertainty due to factors unrelated to the pandemic and adjusting for weather, seasonality, and recent emissions trends. We find that monthly CO2 emissions reductions are only statistically significant in April and May 2020 considering hypothesis tests at 5% significance levels. Separately, we consider the potential impact of COVID-19 on coal-fired power plant retirements through 2022. We find that only a small percentage of U.S. coal power plants are at risk of retirement due to a possible COVID-19-related sustained reduction in electricity demand and prices. We observe and anticipate a return to pre-COVID-19 CO2 emissions in the U.S. power sector.

Slow Momentum with Fast Reversion: A Trading Strategy Using Deep Learning and Changepoint Detection
Kieran Wood,Stephen Roberts,Stefan Zohren
arXiv

Momentum strategies are an important part of alternative investments and are at the heart of commodity trading advisors (CTAs). These strategies have however been found to have difficulties adjusting to rapid changes in market conditions, such as during the 2020 market crash. In particular, immediately after momentum turning points, where a trend reverses from an uptrend (downtrend) to a downtrend (uptrend), time-series momentum (TSMOM) strategies are prone to making bad bets. To improve the response to regime change, we introduce a novel approach, where we insert an online change-point detection (CPD) module into a Deep Momentum Network (DMN) [1904.04912] pipeline, which uses an LSTM deep-learning architecture to simultaneously learn both trend estimation and position sizing. Furthermore, our model is able to optimise the way in which it balances 1) a slow momentum strategy which exploits persisting trends, but does not overreact to localised price moves, and 2) a fast mean-reversion strategy regime by quickly flipping its position, then swapping it back again to exploit localised price moves. Our CPD module outputs a changepoint location and severity score, allowing our model to learn to respond to varying degrees of disequilibrium, or smaller and more localised changepoints, in a data driven manner. Using a portfolio of 50, liquid, continuous futures contracts over the period 1990-2020, the addition of the CPD module leads to an improvement in Sharpe ratio of $33\%$. Even more notably, this module is especially beneficial in periods of significant nonstationarity, and in particular, over the most recent years tested (2015-2020) the performance boost is approximately $400\%$. This is especially interesting as traditional momentum strategies have been underperforming in this period.

SoK: Yield Aggregators in DeFi
Simon Cousaert,Jiahua Xu,Toshiko Matsui
arXiv

Yield farming has been an immensely popular activity for cryptocurrency holders since the explosion of Decentralized Finance (DeFi) in the summer of 2020. In this Systematization of Knowledge (SoK), we study a general framework for yield farming strategies with empirical analysis. First, we summarize the fundamentals of yield farming by focusing on the protocols and tokens used by aggregators. We then examine the sources of yield and translate those into three example yield farming strategies, followed by the simulations of yield farming performance, based on these strategies. We further compare four major yield aggregrators -- Idle, Pickle, Harvest and Yearn -- in the ecosystem, along with brief introductions of others. We systematize their strategies and revenue models, and conduct an empirical analysis with on-chain data from example vaults, to find a plausible connection between data anomalies and historical events. Finally, we discuss the benefits and risks of yield aggregators.

Three Remarks On Asset Pricing
Victor Olkhov
arXiv

We make three remarks to the main CAPM equation presented in the well-known textbook by John Cochrane (2001). First, we believe that any economic averaging procedure implies aggregation of corresponding time series during certain time interval ${\Delta}$ and explain the necessity to use math expectation for both sides of the main CAPM equation. Second, the first-order condition of utility max used to derive main CAPM equation should be complemented by the second one that requires negative utility second derivative. Both define the amount of assets ${\xi}_{max}$ that delivers max to utility. Expansions of the utility in a Taylor series by price and payoff variations give approximations for ${\xi}_{max}$ and uncover equations on price, payoff, volatility, skewness, their covariance's and etc. We discuss why market price-volume positive correlations may prohibit existence of ${\xi}_{max}$ and main CAPM equation. Third, we argue that the economic sense of the conventional frequency-based price probability may be poor. To overcome this trouble we propose new price probability measure based on widely used volume weighted average price (VWAP). To forecast price volatility one should predict evolution of squares of the value and the volume of market trades aggregated during averaging interval ${\Delta}$. The forecast of the new price probability measure may be the main tough puzzle for CAPM and finance. However investors are free to chose any probability measure they prefer as ground for their investment strategies but should be ready for unexpected losses due to possible distinctions with real market trade price dynamics.