Research articles for the 2021-07-16

Assessing the Safety of Central Counterparties
Paddrik, Mark E.,Young, Peyton
We propose a general framework for empirically assessing a central counterparty's capacity to cope with severe financial stress. Using public disclosure data for global central counterparties (CCPs), we show how to estimate the probability that a CCP could cover any specified fraction of payment defaults by its members. This framework supplements conventional standards of assessing risk protection across CCPs that is not predicated on a specific number of member defaults. We apply the approach to a wide range of CCPs in different geographical jurisdictions and asset classes and find that there are substantial differences in protection coverage. In particular, large European CCPs appear to be significantly safer than their counterparts in Asia-Pacific and North America. These differences are also reflected in supervisory data that provide CCP members' risk assessments of the CCPs to which they belong.

Banking Market Structure and Trade Shocks
Izadi, Mohammad,Saadi, Vahid
We study how the structure of the local banking market characterized by bank specialization and bank concentration affects credit and labor market responses to an import shock to local economies. We find that during the surge in U.S. imports from China from 1998 to 2006, small business loans (SBL) decline in counties that face a larger import shock. We show that bank geographical specialization positively affects banks' SBL origination in response to the import shock, while we do not find a significant effect with respect to bank concentration. Consistent with these results, we show that while on average employment and wages decline in counties hit by the import shock, higher bank specialization attenuates these negative labor outcomes, whereas bank concentration does not seem to have such attenuation effects.

Banks' Market Power, Access to Finance, and Leverage
Bustamante, Maria Cecilia,D'Acunto, Francesco
How does lending-market competitiveness affect new firms' financing? Using a unique US representative panel of new firms, we document that in more concentrated local lending markets: (i) new firms are less likely to access credit; (ii) new firms have lower leverage; and (iii) the best performing firms are more severely affected by reduced debt financing. We develop a contingent-claims model with monopolistically competitive banks that rationalizes these facts and shows how credit-market conditions determine loan fees and concentration. Our findings highlight banks' market power as a channel through which the financial sector influences firms' development and, hence, economic growth.

Benefits of Having a Female CFO
Klevak, Julia,Livnat, Joshua,Suslava, Kate
We examine gender differences in the language of CFOs that participate in quarterly earnings calls. Female executives are more concise, less optimistic, are clearer, use fewer idioms or clichés, and provide more numbers in their speech. These differences are particularly strong in the more spontaneous Questions and Answers (QA) section of the calls. The tone of female CFOs is positively associated with future earnings surprises, while for male CFOs it is more related to future firm expansion. Finally, firms with female CFOs earn higher abnormal returns around the call date than those with male CFOs after controlling for variables that are related to the contents of the call.

Causes and Effects of Worldwide Demutualization of Financial Exchanges
Jain, Chinmay,Jain, Pankaj K.,Taylor, David A.
We examine how the forces of automation, competition, and demutualization are rapidly changing the industrial organization, ownership, and capital structure of the financial exchange industry. We propose the conditions under which demutualization becomes optimal from the perspective of mutually owned exchange owners. We then proceed to build an empirical dataset characterizing the evolution of the leading stock and derivative exchanges around the World along these dimensions. We empirically find that technology driven growth opportunities, product driven growth opportunities and increases in market concentration are the main stimulants for demutualization. These factors remain strongly significant in explaining demutualization after controlling for market capitalization, trading volume and economic freedom environment within the country where the exchange is domiciled. Finally, we analyze the impact of demutualization from the perspectives of other stakeholders in financial markets. Turnover and liquidity for investors improve after demutualization, helping reduce the cost of capital for corporations.

Corporate Announcements and Market Efficiency: A Case on Indian Capital Market
Marisetty, Nagendra,Madasu, Pardhasaradhi
Capital markets being the backbone of the economy, are expected to be functioning efficiently. Efficiently-priced financial markets are considered a catalyst for the economic growth of the nations (Malkiel, 2010). Efficient markets are the reflection of security valuations. In an informationally efficient market, no one can beat the market and make abnormal returns based on the information because the information is instantaneously observed in the stock prices. The current paper analyses the market efficiency of three of the most popular corporate events, i.e., announcement of cash dividends, bonus issues, and stock split in the Indian context. The sample is 2253 pure cash dividend announcements (627 large-caps, 552 mid-caps, and 1074 small-caps), 152 bonus issue announcements (49 large-caps, 33 mid-caps, and 70 small-caps), and 181 stock split announcements (35 large-caps, 34 mid-caps, and 112 small-caps) were used for this study. Event methodology market model used to calculate Average Abnormal Returns (AAR) and Cumulative Average Abnormal Returns (CAAR).The results of the study have few findings which are contradictory to the existing literature on market efficiency. The cash dividend announcements have shown evidence for market efficiency, and results are contrary to Gupta et al. (2012), but the results are similar to Mishra (2005). Bonus issue announcements also have shown evidence for a semi-strong form of efficiency, test results identical to Dhar and Chhaochharia (2008), Kumar and Mittal (2015). Stock split announcements have not shown market efficiency, and the effect is similar to the study of Lakshmi and Roy (2012) and contrary to Chavali and Zahid (2011). Our results also support the premise that the emergingcountries depict evidence of market efficiency (Bechev, 2003). Finally, we conclude that market efficiency results differ based on corporate announcements and market capitalization.

Correlation scenarios and correlation stress testing
Packham, Natalie,Woebbeking, Fabian
We develop a general approach for stress testing correlations of financial asset portfolios. The correlation matrix of asset returns is specified in a parametric form, where correlations are represented as a function of risk factors, such as country and industry factors. A sparse factor structure linking assets and risk factors is built using Bayesian variable selection methods. Regular calibration yields a joint distribution of economically meaningful stress scenarios of the factors. As such, the method also lends itself as a reverse stress testing framework: using the Mahalanobis distance or highest density regions (HDR) on the joint risk factor distribution allows to infer worst-case correlation scenarios. We give examples of stress tests on a large portfolio of European and North American stocks.

Counterparty Choice, Bank Interconnectedness, and Systemic Risk
Ellul, Andrew,Kim, Dasol
We provide evidence on how banks form network connections and endogenous risk-taking in their non-bank counterparty choices in the OTC derivative markets. We use confidential regulatory data from the Capital Assessment and Stress Testing reports that provide counterparty-level data across a wide range of OTC markets for the most systemically important U.S. banks. We show that banks are more likely to either establish or maintain a relationship, and increase their exposures within an existing relationship, with non-bank counterparties that are already heavily connected and exposed to other banks. Banks in such densely-connected networks are more likely to connect with riskier counterparties for their most material exposures. The effects are strongest in the case of (non-bank) financial counterparties. These findings suggest moral hazard behavior in counterparty choices. Finally, we demonstrate that these exposures are strongly linked to systemic risk. Overall, the results suggest a network formation process that amplifies risk propagation through non-bank linkages in opaque financial markets.

Diseconomies of Scale in Active Management: Robust Evidence
Pastor, Lubos,Stambaugh, Robert F.,Taylor, Lucian A.,Zhu, Min
We take a deeper look at the robustness of evidence presented by Pastor, Stambaugh, and Taylor (2015) and Zhu (2018), who find that an actively managed mutual fund's returns relate negatively to both fund size and the size of the active mutual fund industry. When we apply robust regression methods, we confirm both studies' inferences about scale diseconomies at the fund and industry levels. Moreover, data errors play no role, as both studies' results are insensitive to applying various error screens and using alternative return benchmarks. We reject constant returns to scale even after dropping 25% of the most extreme return observations. Finally, we caution that asymmetric removal of influential observations delivers biased conclusions about diseconomies of scale.

ETFs, Illiquid Assets, and Fire Sales
Shim, John J.,Todorov, Karamfil
We document several novel facts about exchange-traded funds (ETFs) holding corporate bonds. First, the portfolio of bonds that are exchanged for new or existing ETF shares (called creation or redemption baskets) often represents a small fraction of ETF holdings â€" a fact that we call “fractional baskets.” Second, creation and redemption baskets exhibit high turnover. Third, creation (redemption) baskets tend to have longer (shorter) durations and smaller (larger) bid-ask spreads relative to holdings. Lastly, ETFs with fractional baskets exhibit persistent premiums and discounts, which is related to the slow adjustment of NAV returns to ETF returns. We develop a simple model to show that an ETF’s authorized participants (APs) can act as a buffer between the ETF market and the underlying illiquid assets, and help mitigate fire sales. Our findings suggest that ETFs may be more effective in managing illiquid assets than mutual funds.

India's inclusive growth - an approach based on TOPSIS method
Goel, Anusha
This study analyses the achievement of 32 Indian states and union territories in the inclusiveness of financial system, their relative position, major emerging trends and computes the rate of growth during a period of 2000-01 to 2016-17. The level of inclusion is determined using technique of order preference by similarity to ideal solution (TOPSIS) method and growth rate is computed by log linear regression model. The results indicate that states and union territories have secured different level of inclusiveness of financial system. While the situation has seen tremendous improvement in approximately twenty percent states/union territories, it has faced significant decline in thirteen percent states/union territories. There is no robust change in as many as seventy percent states/union territories. These dynamics in the extent of financial inclusion will act as guide in policy formulation by concerned authorities.

Is the Value Premium Smaller Than We Thought?
Hasler, Mathias
The construction of the original HML portfolio (Fama and French, 1993) includes six seemingly innocuous decisions that could easily have been replaced with alternatives that are just as reasonable. I propose such alternatives and construct HML portfolios. In sample, the average estimate of the value premium is dramatically smaller than the original estimate of the value premium. The difference is 0.09% per month and statistically significant. Out of sample, however, this difference is statistically indistinguishable from zero. The results suggest that the original value premium estimate is upward biased because of a chance result in the original research decisions.

Mandated Performance Disclosure and Managerial Risk-Taking
Heater, John C.
I document that mandated performance disclosure increased managerial risk-taking, resulting in significant unintended consequences and agency conflicts. After the SEC required that all mutual funds disclose a self-selected primary benchmark, I find that most fund managers chose a benchmark that was not the best fit index. Furthermore, I provide evidence that actively managed funds increased risk-taking relative to their disclosed benchmarks in response to the disclosure change. I also find that the mandated disclosure requirement exacerbated the well-documented tendency of managers who underperform during the first half of the year to increase the risks they take in the second half of the year.

Performance of Various Order Statistics Filters in Impulse and Mixed Noise Removal for RS Images
Radhika, V.,G, Padmavathi
Remote sensing images (ranges from satellite to seismic) are affected by number of noises like interference, impulse and speckle noises. Image denoising is one of the traditional problems in digital image processing, which plays vital role as a pre-processing step in number of image and video applications. Image denoising still remains a challenging research area for researchers because noise removal introduces artifacts and causes blurring of the images. This study is done with the intension of designing a best algorithm for impulsive noise reduction in an industrial environment. A review of the typical impulsive noise reduction systems which are based on order statistics are done and particularized for the described situation. Finally, computational aspects are analyzed in terms of PSNR values and some solutions are proposed.

Right-to-Work Laws: A Brief Review
Gondhalekar, Vijay,Kessler, Lara
This study provides a review of important legal cases and empirical studies on Right-to-Work RTW laws. Twenty-seven US states have passed RTW laws since 1946, but the proposed Protecting the Right to Organize (PRO) Act 2021 intends to override some of their important provisions. Evidence on RTW laws will therefore be widely in demand as the PRO Act starts getting increased legislative attention. Our study provides a brief background on RTW laws, reviews important legal cases, groups congruous empirical findings into broad themes, identifies topics on which there is still turbidity in findings, and points out areas that are likely to receive increased research attention going forward.

The Infinite Horizon Investment-Consumption Problem for Epstein-Zin Stochastic Differential Utility
Jerome, Joseph,Herdegen, Martin,Hobson, David
In this article, we consider the optimal investment-consumption problem for an agent with preferences governed by Epstein-Zin stochastic differential utility who invests in a constant-parameter Black-Scholes-Merton market.The paper has three main goals: first, to provide a detailed introduction to infinite-horizon Epstein-Zin stochastic differential utility, including a discussion of which parameter combinations lead to a well-formulated problem; second, to prove existence and uniqueness of infinite horizon Epstein-Zin stochastic differential utility under a restriction on the parameters governing the agent's risk aversion and temporal variance aversion; and third, to provide a verification argument for the candidate optimal solution to the investment-consumption problem among all admissible consumption streams.To achieve these goals, we introduce a slightly different formulation of Epstein-Zin stochastic differential utility to that which is traditionally used in the literature. This formulation highlights the necessity and appropriateness of certain restrictions on the parameters governing the stochastic differential utility function.

The Structure and Degree of Dependence in Government Bond Markets
Dimic, Nebojsa,Piljak, Vanja,Swinkels, Laurens,Vulanovic, Milos
Our study provides new evidence on asymmetric dependencies in international government bond markets, by examining bonds from developed, emerging, and frontier countries, using a quantile regression methodology. We find that the dependence structure for emerging and frontier markets significantly changes during financial crisis periods, which we show has important implications for international diversification of investment strategies. Moreover, we also examine in detail stock-bond correlations and uncover several instances of decoupling. In contrast, developed markets exhibit a more stable dependence pattern. In addition, we document that the degree and structure of dependence vary when foreign currencies are hedged or unhedged, and across bond maturity segments.

Uncovering Retail Trading in Bitcoin: The Impact of COVID-19 Stimulus Checks
Divakaruni, Anantha,Zimmerman, Peter
In April 2020, the US government sent economic impact payments (EIPs) directly to households, as part of its measures to address the COVID-19 pandemic. We characterize these stimulus checks as a wealth shock for households and examine their effect on retail trading in Bitcoin. We find a significant increase in Bitcoin buy trades for the modal EIP amount of $1,200. The rise in Bitcoin trading is highest among individuals without families and at exchanges catering to nonprofessional investors. We estimate that the EIP program has a significant but modest effect on the US dollar–Bitcoin trading pair, increasing trade volume by about 3.8 percent. Trades associated with the EIPs result in a slight rise in the price of Bitcoin of 7 basis points. Nonetheless, the increase in trading is small compared to the size of the stimulus check program, representing only 0.02 percent of all EIP dollars. We repeat our analysis for other countries with similar stimulus programs and find an increase in Bitcoin buy trades in these currencies. Our findings highlight how wealth shocks affect retail trading.