Research articles for the 2021-07-25

A bridge between Local GAAP and Solvency II frameworks to quantify Capital Requirement for demographic risk
Gian Paolo Clemente,Francesco Della Corte,Nino Savelli

The paper provides a stochastic model useful for assessing the capital requirement for demographic risk. The model extends to the market consistent context classical methodologies developed in a local accounting framework. In particular we provide a unique formulation for different non-participating life insurance contracts and we prove analytically that the valuation of demographic profit can be significantly affected by the financial conditions in the market. A case study has been also developed considering a portfolio of life insurance contracts. Results prove the effectiveness of the model in highlighting main drivers of capital requirement evaluation, also compared to local GAAP framework.

COVID-19 and the gig economy in Poland
Maciej Beręsewicz,Dagmara Nikulin

We use a dataset covering nearly the entire target population based on passively collected data from smartphones to measure the impact of the first COVID-19 wave on the gig economy in Poland. In particular, we focus on transportation (Uber, Bolt) and delivery (Wolt, Takeaway, Glover, DeliGoo) apps, which make it possible to distinguish between the demand and supply part of this market. Based on Bayesian structural time-series models, we estimate the causal impact of the first COVID-19 wave on the number of active drivers and couriers. We show a significant relative increase for Wolt and Glover (15% and 24%) and a slight relative decrease for Uber and Bolt (-3% and -7%) in comparison to a counterfactual control. The change for Uber and Bolt can be partially explained by the prospect of a new law (the so-called Uber Lex), which was already announced in 2019 and is intended to regulate the work of platform drivers.

Dealing with Uncertainty: The Value of Reputation in the Absence of Legal Institutions
Nicolas Eschenbaum,Helge Liebert

This paper studies reputation in the online market for illegal drugs in which no legal institutions exist to alleviate uncertainty. Trade takes place on platforms that offer rating systems for sellers, thereby providing an observable measure of reputation. The analysis exploits the fact that one of the two dominant platforms unexpectedly disappeared. Re-entering sellers reset their rating. The results show that on average prices decreased by up to 9% and that a 1% increase in rating causes a price increase of 1%. Ratings and prices recover after about three months. We calculate that identified good types earn 1,650 USD more per week.

Deep equal risk pricing of financial derivatives with non-translation invariant risk measures
Alexandre Carbonneau,Frédéric Godin

The use of non-translation invariant risk measures within the equal risk pricing (ERP) methodology for the valuation of financial derivatives is investigated. The ability to move beyond the class of convex risk measures considered in several prior studies provides more flexibility within the pricing scheme. In particular, suitable choices for the risk measure embedded in the ERP framework such as the semi-mean-square-error (SMSE) are shown herein to alleviate the price inflation phenomenon observed under Tail Value-at-Risk based ERP as documented for instance in Carbonneau and Godin (2021b). The numerical implementation of non-translation invariant ERP is performed through deep reinforcement learning, where a slight modification is applied to the conventional deep hedging training algorithm (see Buehler et al., 2019) so as to enable obtaining a price through a single training run for the two neural networks associated with the respective long and short hedging strategies. The accuracy of the neural network training procedure is shown in simulation experiments not to be materially impacted by such modification of the training algorithm.

Economic Recession Prediction Using Deep Neural Network
Zihao Wang,Kun Li,Steve Q. Xia,Hongfu Liu

We investigate the effectiveness of different machine learning methodologies in predicting economic cycles. We identify the deep learning methodology of Bi-LSTM with Autoencoder as the most accurate model to forecast the beginning and end of economic recessions in the U.S. We adopt commonly-available macro and market-condition features to compare the ability of different machine learning models to generate good predictions both in-sample and out-of-sample. The proposed model is flexible and dynamic when both predictive variables and model coefficients vary over time. It provided good out-of-sample predictions for the past two recessions and early warning about the COVID-19 recession.

Financial Markets and the Phase Transition between Water and Steam
Christof Schmidhuber

Motivated by empirical observations on the interplay of trends and reversion, a lattice gas model of financial markets is presented. The shares of an asset are modeled by gas molecules that are distributed across a hidden social network of investors. The model is equivalent to the Ising model on this network, whose magnetization represents the deviation of the asset price from its value. It is argued that the system is driven to its critical temperature in efficient markets. There, it is characterized by universal critical exponents, in analogy with the second-order phase transition between water and steam. These critical exponents imply predictions for the auto-correlations of financial market returns. For a simple network topology, consistency with the observed long-term auto-correlations implies a fractal network dimension of 3.3, and a correlation time of 10 years. To also explain the observed short-term auto-correlations, the model should be extended beyond the critical domain, to other network topologies, and to other models of critical dynamics.

Graph-Based Learning for Stock Movement Prediction with Textual and Relational Data
Qinkai Chen,Christian-Yann Robert

Predicting stock prices from textual information is a challenging task due to the uncertainty of the market and the difficulty understanding the natural language from a machine's perspective. Previous researches focus mostly on sentiment extraction based on single news. However, the stocks on the financial market can be highly correlated, one news regarding one stock can quickly impact the prices of other stocks. To take this effect into account, we propose a new stock movement prediction framework: Multi-Graph Recurrent Network for Stock Forecasting (MGRN). This architecture allows to combine the textual sentiment from financial news and multiple relational information extracted from other financial data. Through an accuracy test and a trading simulation on the stocks in the STOXX Europe 600 index, we demonstrate a better performance from our model than other benchmarks.

LocalGLMnet: interpretable deep learning for tabular data
Ronald Richman,Mario V. Wüthrich

Deep learning models have gained great popularity in statistical modeling because they lead to very competitive regression models, often outperforming classical statistical models such as generalized linear models. The disadvantage of deep learning models is that their solutions are difficult to interpret and explain, and variable selection is not easily possible because deep learning models solve feature engineering and variable selection internally in a nontransparent way. Inspired by the appealing structure of generalized linear models, we propose a new network architecture that shares similar features as generalized linear models, but provides superior predictive power benefiting from the art of representation learning. This new architecture allows for variable selection of tabular data and for interpretation of the calibrated deep learning model, in fact, our approach provides an additive decomposition in the spirit of Shapley values and integrated gradients.

Margin Trading, Short-Selling and Corporate Green Innovation
Ge-zhi Wu,Da-ming You

This paper uses the panel data of Chinese listed companies from 2007 to 2019, uses the relaxation of China's margin trading and Short-Selling restrictions as the basis of quasi experimental research, and then constructs a double difference model to analyze whether the margin trading and Short-Selling will encourage enterprises to engage in green technology innovation activities. Firstly, our research results show that after the implementation of the margin trading and Short-Selling, the green technology innovation behavior of pilot companies will increase significantly. We believe that the short selling threat and pressure brought by short selling to enterprises are the main reasons for pilot enterprises to engage in green technology innovation. Secondly, the empirical results show that the implementation of margin trading and Short-Selling restrictions will significantly promote the number of green technology innovation of pilot enterprises, but will not promote the quality of green technology innovation of pilot enterprises. Furthermore, we analyze the difference of the impact of margin trading and Short-Selling restrictions on the number of green technology innovation of pilot enterprises in different periods. Finally, we find that the yield gap between financial assets and operating assets, the risk of stock price decline, management shareholding, institutional shareholding ratio, weak product market competition and bull market will affect the role of short selling in promoting green technology innovation of pilot enterprises.

Optimum Risk Portfolio and Eigen Portfolio: A Comparative Analysis Using Selected Stocks from the Indian Stock Market
Jaydip Sen,Sidra Mehtab

Designing an optimum portfolio that allocates weights to its constituent stocks in a way that achieves the best trade-off between the return and the risk is a challenging research problem. The classical mean-variance theory of portfolio proposed by Markowitz is found to perform sub-optimally on the real-world stock market data since the error in estimation for the expected returns adversely affects the performance of the portfolio. This paper presents three approaches to portfolio design, viz, the minimum risk portfolio, the optimum risk portfolio, and the Eigen portfolio, for seven important sectors of the Indian stock market. The daily historical prices of the stocks are scraped from Yahoo Finance website from January 1, 2016, to December 31, 2020. Three portfolios are built for each of the seven sectors chosen for this study, and the portfolios are analyzed on the training data based on several metrics such as annualized return and risk, weights assigned to the constituent stocks, the correlation heatmaps, and the principal components of the Eigen portfolios. Finally, the optimum risk portfolios and the Eigen portfolios for all sectors are tested on their return over a period of a six-month period. The performances of the portfolios are compared and the portfolio yielding the higher return for each sector is identified.

Reference Class Selection in Similarity-Based Forecasting of Sales Growth
Etienne Theising,Dominik Wied,Daniel Ziggel

This paper proposes a method to find appropriate outside views for sales forecasts of analysts. The idea is to find reference classes, i.e. peer groups, for each analyzed company separately. Hence, additional companies are considered that share similarities to the firm of interest with respect to a specific predictor. The classes are regarded to be optimal if the forecasted sales distributions match the actual distributions as closely as possible. The forecast quality is measured by applying goodness-of-fit tests on the estimated probability integral transformations and by comparing the predicted quantiles. The method is applied on a data set consisting of 21,808 US firms over the time period 1950 - 2019, which is also descriptively analyzed. It appears that in particular the past operating margins are good predictors for the distribution of future sales. A case study with a comparison of our forecasts with actual analysts' estimates emphasizes the relevance of our approach in practice.

Stability of backward stochastic differential equations: the general case
Antonis Papapantoleon,Dylan Possamaï,Alexandros Saplaouras

In this paper, we obtain stability results for backward stochastic differential equations with jumps (BSDEs) in a very general framework. More specifically, we consider a convergent sequence of standard data, each associated to their own filtration, and we prove that the associated sequence of (unique) solutions is also convergent. The current result extends earlier contributions in the literature of stability of BSDEs and unifies several frameworks for numerical approximations of BSDEs and their implementations.

Trends, Reversion, and Critical Phenomena in Financial Markets
Christof Schmidhuber

Financial markets across all asset classes are known to exhibit trends. These trends have been exploited by traders for decades. Here, we empirically measure when trends revert, based on 30 years of daily futures prices for equity indices, interest rates, currencies and commodities. We find that trends tend to revert once they reach a critical level of statistical significance. Based on polynomial regression, we carefully measure this critical level. We find that it is universal across asset classes and has a universal scaling behavior, as the trend's time horizon runs from a few days to several years. The corresponding regression coefficients are small, but statistically highly significant, as confirmed by bootstrapping and out-of-sample testing. Our results signal to investors when to exit a trend. They also reveal how markets have become more efficient over the decades. Moreover, they point towards a potential deep analogy between financial markets and critical phenomena: our analysis supports the conjecture that financial markets can be modeled as statistical mechanical ensembles of Buy/Sell orders near critical points. In this analogy, the trend strength plays the role of an order parameter, whose dynamcis is described by a Langevin equation with a quartic potential.

Where do I rank? Am I happy?: learning income position and subjective-wellbeing in an internet experiment
Eiji Yamamura

A tailor-made internet survey experiment provides individuals with information on their income positions to examine their effects on subjective well-being. In the first survey, respondents were asked about their household income and subjective well-being. Based on the data collected, three different respondents' income positions within the residential locality, within a group of the same educational background, and cohort were obtained. In the follow-up survey for the treatment group, respondents are informed of their income positions and then asked for subjective well-being. Key findings are that, after obtaining information, a higher individual's income position improves their subjective well-being. The effects varied according to individual characteristics and proxies.