Research articles for the 2021-07-03
A Neural Network with Shared Dynamics for Multi-Step Prediction of Value-at-Risk and Volatility
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We develop a LSTM neural network for the joint prediction of volatility, realized volatility and Value-at-Risk. Regularization by means of pooling the dynamic structure for the different outputs of the models is shown to be a powerful method for improving forecasts and smoothing VaR estimates. The method is applied to daily and high-frequency returns of the S&P500 index over a period of 25 years.
SSRN
We develop a LSTM neural network for the joint prediction of volatility, realized volatility and Value-at-Risk. Regularization by means of pooling the dynamic structure for the different outputs of the models is shown to be a powerful method for improving forecasts and smoothing VaR estimates. The method is applied to daily and high-frequency returns of the S&P500 index over a period of 25 years.
Balanced Scorecard Approach for Credit Appraisal
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Quality and efficiency of credit appraisal play a key role in the overall credit risk management framework of banks by addressing the troika of adverse selection, exposure risk, and default risk. Traditional approaches for credit appraisal primarily use techniques of financial statement analysis for assessment of the creditworthiness of potential borrowers. However, such analysis fails to provide a 360-degree view of the potential borrower and therefore, requires the implementation of better, incisive, and comprehensive methods. Use of balanced scorecard in credit appraisal expands the horizon of analysis and provides a holistic view about the risk, repayment capacity, and future prospects of the potential borrower.
SSRN
Quality and efficiency of credit appraisal play a key role in the overall credit risk management framework of banks by addressing the troika of adverse selection, exposure risk, and default risk. Traditional approaches for credit appraisal primarily use techniques of financial statement analysis for assessment of the creditworthiness of potential borrowers. However, such analysis fails to provide a 360-degree view of the potential borrower and therefore, requires the implementation of better, incisive, and comprehensive methods. Use of balanced scorecard in credit appraisal expands the horizon of analysis and provides a holistic view about the risk, repayment capacity, and future prospects of the potential borrower.
Can Environmental Policy Encourage Technical Change? Emissions Taxes and R&D Investment in Polluting Firms
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Higher country taxes on noxious manufacturing emissions lead to substantial increases in firm R&D spending. The R&D response is driven entirely by the high-pollution firms most affected by emissions taxes. Pollution taxes increase the market value of R&D spending in polluting firms, even when this spending does not lead to new innovation. Pollution taxes have the strongest effect on R&D investment in sectors where new invention is harder to appropriate and outside knowledge is easier to acquire, suggesting an important reason dirty firms invest in R&D is to expand their capacity to absorb external knowledge and technical know-how.
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Higher country taxes on noxious manufacturing emissions lead to substantial increases in firm R&D spending. The R&D response is driven entirely by the high-pollution firms most affected by emissions taxes. Pollution taxes increase the market value of R&D spending in polluting firms, even when this spending does not lead to new innovation. Pollution taxes have the strongest effect on R&D investment in sectors where new invention is harder to appropriate and outside knowledge is easier to acquire, suggesting an important reason dirty firms invest in R&D is to expand their capacity to absorb external knowledge and technical know-how.
Can Staggered Boards Improve Value? Causal Evidence from Massachusetts
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Staggered boards (SBs) are one of the most potent common entrenchment devices, and their value effects are considerably debated. We study SBs’ effects on firm value, managerial behavior, and investor composition using a quasi-experimental setting: a 1990 law that imposed an SB on all Massachusetts-incorporated firms. We find that relative to a matched control group of companies, for treated companies the law led to an increase in Tobin’s Q, investment in CAPEX and R&D, patents, higher-quality patented innovations, and resulted in higher profitability. These effects are concentrated in innovating firms, especially those facing greater Wall Street scrutiny. An increase in institutional and dedicated investors also accompanied the imposition of SBs, facilitating a longer-term orientation. The evidence suggests SBs can benefit early-life-cycle firms facing high information asymmetries by allowing their managers to focus on long-term investments and innovations.
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Staggered boards (SBs) are one of the most potent common entrenchment devices, and their value effects are considerably debated. We study SBs’ effects on firm value, managerial behavior, and investor composition using a quasi-experimental setting: a 1990 law that imposed an SB on all Massachusetts-incorporated firms. We find that relative to a matched control group of companies, for treated companies the law led to an increase in Tobin’s Q, investment in CAPEX and R&D, patents, higher-quality patented innovations, and resulted in higher profitability. These effects are concentrated in innovating firms, especially those facing greater Wall Street scrutiny. An increase in institutional and dedicated investors also accompanied the imposition of SBs, facilitating a longer-term orientation. The evidence suggests SBs can benefit early-life-cycle firms facing high information asymmetries by allowing their managers to focus on long-term investments and innovations.
Financial Development, Human Capital Development and Climate Change in East and Southern Africa
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Africa is currently experiencing both financial and human development challenges. While several continents have advocated for financial development in order to acquire environmentally friendly machinery that produces less emissions and ensures long-term sustainability, Africa is still lagging behind the rest of the world. Similarly, Africa's human development has remained stagnant, posing a serious threat to climate change if not addressed. Building on the underpinnings of the Environmental Kuznets Curve (EKC) hypothesis on the nexus between economic growth and environmental pollution, this study contributes to empirical research seeking to promote environmental sustainability as follows. First, it investigates the link between financial development, human capital development and climate change in East and Southern Africa. Second, six advanced panel techniquesare used, and they include: (1) cross-sectional dependency (CD) tests; (2) combined panel unit root tests; (3) combined panel cointegration tests; (4) panel VAR/VEC Granger causality tests and (5) combined variance decomposition analysis based on Cholesky and Generalised weights. Our finding shows that financial and human capital developments are important in reducing CO2 emissions and promoting environmental sustainability in East and Southern Africa.
SSRN
Africa is currently experiencing both financial and human development challenges. While several continents have advocated for financial development in order to acquire environmentally friendly machinery that produces less emissions and ensures long-term sustainability, Africa is still lagging behind the rest of the world. Similarly, Africa's human development has remained stagnant, posing a serious threat to climate change if not addressed. Building on the underpinnings of the Environmental Kuznets Curve (EKC) hypothesis on the nexus between economic growth and environmental pollution, this study contributes to empirical research seeking to promote environmental sustainability as follows. First, it investigates the link between financial development, human capital development and climate change in East and Southern Africa. Second, six advanced panel techniquesare used, and they include: (1) cross-sectional dependency (CD) tests; (2) combined panel unit root tests; (3) combined panel cointegration tests; (4) panel VAR/VEC Granger causality tests and (5) combined variance decomposition analysis based on Cholesky and Generalised weights. Our finding shows that financial and human capital developments are important in reducing CO2 emissions and promoting environmental sustainability in East and Southern Africa.
How Wall Street's 'Dirty Little Secret' Affects Investor Portfolios
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In the United States, exchange-traded funds can defer capital gains taxes of their investors by taking advantage of a legal loophole, sometimes referred to as Wall Street's "dirty little secret". To quantify the impact of this tax loophole on investor portfolios, we study a rank-dependent expected utility model. We develop an approximation formula for the sensitivity of the optimal investment strategy with respect to changes in the expected asset returns. By applying this approximation formula, we are able to quantitatively estimate how much investor portfolios may change depending on the investment horizon if the tax loophole is closed.
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In the United States, exchange-traded funds can defer capital gains taxes of their investors by taking advantage of a legal loophole, sometimes referred to as Wall Street's "dirty little secret". To quantify the impact of this tax loophole on investor portfolios, we study a rank-dependent expected utility model. We develop an approximation formula for the sensitivity of the optimal investment strategy with respect to changes in the expected asset returns. By applying this approximation formula, we are able to quantitatively estimate how much investor portfolios may change depending on the investment horizon if the tax loophole is closed.
Should Consumers Be Prohibited From Storing Card Data on the Internet?
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In March 2020, the Reserve Bank of India's guidelines on Payment Aggregators and Payment Gateways prohibited merchants from storing data on cards used by customers. This paper argues that a total prohibition on card data storage is problematic as it affects the ease of transactions for consumers, and effectively tilts consumer preference towards other payment instruments. This runs the risk of technological choices in the industry being made or substantially shaped by the regulator. The documents released lack a cost-benefit analysis of this prohibition and do not demonstrate that the chosen intervention is the best one. This raises concerns in the light of emerging Indian jurisprudence on the standards of regulatory governance to be met by statutory regulatory agencies. We show alternative approaches to address concerns relating to breaches of card information stored by consumers on the internet. These include better security standards, tokenization, and liability frameworks.
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In March 2020, the Reserve Bank of India's guidelines on Payment Aggregators and Payment Gateways prohibited merchants from storing data on cards used by customers. This paper argues that a total prohibition on card data storage is problematic as it affects the ease of transactions for consumers, and effectively tilts consumer preference towards other payment instruments. This runs the risk of technological choices in the industry being made or substantially shaped by the regulator. The documents released lack a cost-benefit analysis of this prohibition and do not demonstrate that the chosen intervention is the best one. This raises concerns in the light of emerging Indian jurisprudence on the standards of regulatory governance to be met by statutory regulatory agencies. We show alternative approaches to address concerns relating to breaches of card information stored by consumers on the internet. These include better security standards, tokenization, and liability frameworks.
Translating Economic Essence of the Independence Axiom into a General Equilibrium Mathematical Condition
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Satisfaction of either of the independence axiom, or its less stringent counterpart, `smoothness of utility functions' is necessary condition for robustness of applications of expected utility theory to modeling of choice under uncertainty. This study arrives at a general equilibrium mathematical condition for inferring of, simultaneously, violations of each of the independence axiom or smoothness of utility functions, conditions. In stated respect, inclusive of formal theoretical evidence that concave functions are not well defined, the mathematical condition shows functions that are not `well defined', equivalently, not `one-to-one' induce violations of the independence axiom. With focus on stock markets, the mathematical condition directly implies non-robustness of either of concave or strictly convex functions to modeling of choice under uncertainty. For concreteness, in presence of satisfaction of ordering, continuity, and independence axioms, regardless, adoption of concave utility functions for modeling of choice under uncertainty embeds several reinforcing endogeneities, namely pre-knowledge of the optimum, dichotomization of expectations of positive returns from information, and dependence of expectations of positive returns on increase to risk aversion parameters of economic agents. While strictly convex functions are well defined, contrary to economics of stock markets, adoption of strictly convex utility functions implies existence of numeraire assets, that is, parameterization of stock markets by First Order Stochastic Dominance, as such, arrival at a contradiction. Study findings reiterate importance of searches for new approaches to modeling of choice under uncertainty.
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Satisfaction of either of the independence axiom, or its less stringent counterpart, `smoothness of utility functions' is necessary condition for robustness of applications of expected utility theory to modeling of choice under uncertainty. This study arrives at a general equilibrium mathematical condition for inferring of, simultaneously, violations of each of the independence axiom or smoothness of utility functions, conditions. In stated respect, inclusive of formal theoretical evidence that concave functions are not well defined, the mathematical condition shows functions that are not `well defined', equivalently, not `one-to-one' induce violations of the independence axiom. With focus on stock markets, the mathematical condition directly implies non-robustness of either of concave or strictly convex functions to modeling of choice under uncertainty. For concreteness, in presence of satisfaction of ordering, continuity, and independence axioms, regardless, adoption of concave utility functions for modeling of choice under uncertainty embeds several reinforcing endogeneities, namely pre-knowledge of the optimum, dichotomization of expectations of positive returns from information, and dependence of expectations of positive returns on increase to risk aversion parameters of economic agents. While strictly convex functions are well defined, contrary to economics of stock markets, adoption of strictly convex utility functions implies existence of numeraire assets, that is, parameterization of stock markets by First Order Stochastic Dominance, as such, arrival at a contradiction. Study findings reiterate importance of searches for new approaches to modeling of choice under uncertainty.
Urban Cooperative Banking in India: Key Issues and Way Forward
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Co-operatives are successful business organisations all over the world and have a presence in almost all spheres of economic activities, including banking and financial services. The success of co-operatives shows that it is possible to simultaneously pursue both economic viability and social responsibility through equitable, democratic, and people-centric organizations. However, in India due to various reasons, the Primary (Urban) Co-operative Banks (UCBs) have not been able to achieve their full potential. The UCB sector is highly heterogeneous in terms of asset size and faces several challenges relating to the business model, governance, and professional management. Following the amendments (2020) to the Banking Regulation Act, 1949 (As Applicable to Co-operative Societies), Reserve Bank has recently constituted an expert committee to provide a roadmap for strengthening the sector. This paper focusses upon the key issues faced by the UCB sector and suggests a future direction.
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Co-operatives are successful business organisations all over the world and have a presence in almost all spheres of economic activities, including banking and financial services. The success of co-operatives shows that it is possible to simultaneously pursue both economic viability and social responsibility through equitable, democratic, and people-centric organizations. However, in India due to various reasons, the Primary (Urban) Co-operative Banks (UCBs) have not been able to achieve their full potential. The UCB sector is highly heterogeneous in terms of asset size and faces several challenges relating to the business model, governance, and professional management. Following the amendments (2020) to the Banking Regulation Act, 1949 (As Applicable to Co-operative Societies), Reserve Bank has recently constituted an expert committee to provide a roadmap for strengthening the sector. This paper focusses upon the key issues faced by the UCB sector and suggests a future direction.
