Delia Coculescu, Freddy DELBAEN, Group cohesion under individual regulatory constraints, In: ArXiv.org, No. 2010.0142, 2020. (Working Paper)
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We consider a group consisting of N business units. We suppose there are regulatory constraints for each unit, more precisely, the net worth of each business unit is required to belong to a set of acceptable risks, assumed to be a convex cone. Because of these requirements, there are less incentives to operate under a group structure, as creating one single business unit, or altering the liability repartition among units, may allow to reduce the required capital. We analyse the possibilities for the group to benefit from a diversification effect and economise on the cost of capital. We define and study the risk measures that allow for any group to achieve the minimal capital, as if it were a single unit, without altering the liability of business units, and despite the individual admissibility constraints. We call these risk measures cohesive risk measures, we prove cohesive risk measures are tail expectations but calculated under a different probability. |
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Elena Carletti, Paolo Colla, Mitu G Gulati, Steven Ongena, The Price of Law: The Case of the Eurozone Collective Action Clauses, In: Duke Law School Public Law & Legal Theory Series, No. 2020-73, 2020. (Working Paper)
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We analyze the price effect of the introduction of Collective Action Clauses (CACs) in all newly issued sovereign bonds of Eurozone countries as of January 1, 2013. By allowing a majority of creditors to modify payment obligations, such clauses reduce the likelihood of holdouts while facilitating strategic default by the sovereign. We find that CAC bonds trade in the secondary market at lower yields than otherwise similar no-CAC bonds. The yield differential widens in countries with worse ratings and in those with stronger legal systems. The results suggest that CACs are seen as pro- rather than anti-creditor provisions. |
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Urban Ulrych, Nikola Vasiljevic, Ambiguity and the Home Currency Bias, In: Swiss Finance Institute Research Paper, No. 20-73, 2020. (Working Paper)
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This paper addresses the question of optimal currency exposure for a risk-and-ambiguity-averse international investor. A robust mean-variance model with smooth ambiguity preferences is used to derive the optimal currency exposure. In the theoretical part, we show that the sample-efficient currency demand can be calculated as the solution to a generalized ridge regression. Through the lens of these results, we demonstrate that our ambiguity-based model offers a new explanation of the home currency bias. The investor's dislike for model uncertainty induces a disproportionately high currency hedging demand. The empirical analysis of currency overlay strategies employs the foreign exchange, equity, and bond returns over the period from 1999 to 2018. Our out-of-sample back-tests illustrate that accounting for ambiguity enhances the stability of estimated optimal currency exposures and significantly improves the portfolio performance net of transaction costs. |
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Delia Coculescu, Freddy DELBAEN, Fairness principles for insurance contracts in the presence of default risk, In: ArXiv.org, No. 2009.04408, 2020. (Working Paper)
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We use the theory of cooperative games for the design of fair insurance contracts. An insurance contract needs to specify the premium to be paid and a possible participation in the benefit (or surplus) of the company. It results from the analysis that when a contract is exposed to the default risk of the insurance company, ex-ante equilibrium considerations require a certain participation in the benefit of the company to be specified in the contracts. The fair benefit participation of agents appears as an outcome of a game involving the residual risks induced by the default possibility and using fuzzy coalitions. |
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Christoph Basten, Steven Ongena, The Geography of Mortgage Lending in Times of FinTech, In: CEPR Discussion Papers, No. DP14918, 2020. (Working Paper)
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How does banks' geographical footprint change when a FinTech platform allows offering mortgages to regions without branch presence? Unique data on responses from different banks to each household yield three salient findings: First, banks offer 4% more often and 6 basis points cheaper when markets have high versus low concentration, implying more profitable follow-on business. Second, they offer 2% more often and 2 bps cheaper when unemployment or house price growth in the applicant's state are one standard deviation less correlated with those at home, improving portfolio diversification. Third, these offers are increasingly automated, using available hard information more efficiently. |
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Hua Cheng, Kishore Gawande, Steven Ongena, Shusen Qi, Get beyond policy uncertainty: Evidence from political connections, In: Swiss Finance Institute Research Paper, No. 20-77, 2020. (Working Paper)
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Although policy uncertainty has drawn regulators’ attention in the aftermath of the global financial crisis, little is known on how to alleviate its adverse effects. In this paper, we examine the role of political connections in mitigating the detrimental impact of policy uncertainty on banks. Our estimates show that banks are more cautious when facing policy uncertainty, but that the effect is partially alleviated when banks are politically connected. For an increase of one standard deviation in policy uncertainty, connected banks maintain a loss provision to loan volume ratio that is almost seven percent lower compared to their unconnected peers. These findings are robust to a geographical regression discontinuity setting, as well as to a placebo test. Lastly, the mitigating role of political connections is driven mainly by smaller banks and periods of stricter banking regulations. |
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Pascal Flurin Meier, Raphael Flepp, Egon Franck, Are Sports Betting Markets Semistrong Efficient? Evidence from the COVID-19 Pandemic, In: UZH Business Working Paper Series, No. 387, 2020. (Working Paper)
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This paper examines whether sports betting markets are semistrong-form efficient—i.e., whether new information is rapidly and completely incorporated into betting prices. We use the news of ghost matches in the top European football leagues due to the COVID-19 pandemic as the arrival of public information. Because spectators are absent in ghost games, the home field advantage is reduced, and we test whether this information is fully reflected in betting prices. Our results show that bookmakers systematically overestimate a home team’s winning probability during the first period of the ghost games, which suggests that betting markets are, at least temporally, not semistrong-form efficient. We exploit a betting strategy that yields a positive net payoff over more than one month. |
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Nils Jonathan Krakow, Timo Schäfer, Mutual Funds and Qualitative Disclosure, In: Swiss Finance Institute Research Paper, No. 20-54, 2021. (Working Paper)
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In this paper, we use the content of U.S. mutual funds' prospectuses to examine the informational value of funds' qualitative disclosures. We document significant heterogeneity in the cross-section of funds' qualitative disclosures, primarily attributed to characteristics at the investment company level. Using textual analysis, we decompose funds' qualitative disclosures into informative and standard content. Our results show that funds' risk-taking behavior and risk-adjusted-performance increase with the informativeness of their disclosures. Content-based updates of disclosures are informative about funds' future risk-taking and their future performance. Finally, we document evidence that investors react to some extent to the informativeness of fund disclosures. |
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Artem Dyachenko, Erich Walter Farkas, Marc Oliver Rieger, Volatility Dependent Structured Products, In: Swiss Finance Institute Research Paper, No. 19-64, 2020. (Working Paper)
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We construct a derivative that depends on the SPY and VIX and, in this way, incorporates both the market risk premium and the variance risk premium. We show that the product's Sharpe ratio is higher than the SPY Sharpe ratio. If we invest $10000 into the product, the products' payoff is around $60000 at the end of 2018. In comparison, if we invest $10000 into the SPY, the SPY payoff is around $30000. |
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Manthos D. Delis, Iftekhar Hasan, Maria Iosifidi, Steven Ongena, Gender, Credit, and Firm Outcomes, In: Swiss Finance Institute Research Paper, No. 19-70, 2020. (Working Paper)
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Small and micro enterprises are usually majority owned by entrepreneurs. Using a unique sample of loan applications from such firms, we study the role of owners’ gender in the credit decision of banks and the post-credit decision firm outcomes. We find that, ceteris paribus, female entrepreneurs are more prudent loan applicants, with both the probabilities to apply for credit and of firm default after the loan origination being smaller. However, the relatively more aggressive behavior of male applicants pays off in terms of higher average firm performance after the loan origination. |
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Simon Glossner, Pedro Matos, Stefano Ramelli, Alexander Wagner, Do Institutional Investors Stabilize Equity Markets in Crisis Periods? Evidence from COVID-19, In: Swiss Finance Institute Research Paper, No. 20-56, 2022. (Working Paper)
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During the COVID-19 crash, U.S. stocks with higher institutional ownership performed worse. This under-performance is unrelated to revisions in earnings expectations, which suggests a disconnect between stock prices and firm fundamentals. Two mechanisms were at play: Institutions faced a sudden increase in redemptions and simultaneously attempted to de-risk their portfolios. Most types of institutional investors re-balanced portfolios toward financially strong firms, whereas hedge funds sold indiscriminately. Data from a discount brokerage (Robinhood) confirm that retail investors provided liquidity. Overall, the results suggest that when a tail risk realizes, institutional investors amplify price crashes. |
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Hanlin Yang, Decomposing Factor Momentum, In: SSRN, No. 3517888, 2020. (Working Paper)
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Factor momentum returns do not stem from momentum in factor returns. To study the source of returns, this paper decomposes the factor momentum portfolio into a factor timing portfolio and a static portfolio, where the former dynamically collects the return due to serial correlations of factor returns and the latter passively collects factor premiums. Evidence from 210 stock return factors reveals that the static portfolio robustly accounts for a dominant fraction of the factor momentum return and outperforms in risk-adjusted returns, whereas factor return predictability is empirically too weak to produce timing benefits. The static portfolio survives the post-publication decline of factor performance but the factor momentum portfolio does not. |
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Stefano Ramelli, Elisa Ossola, Michela Rancan, Climate Sin Stocks: Stock Price Reactions to Global Climate Strikes, In: JRC Working Papers in Economics and Finance, No. JRC120974, 2020. (Working Paper)
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The first Global Climate Strike on March 15, 2019 has represented a historical turn in climate activism. We investigate the cross-section of European stock price reactions to this event. Looking at a large sample of European firms, we find that the unanticipated success of this event caused a substantial stock price reaction on high-carbon intensity companies. These findings are likely driven by an update of investors' beliefs about the level of environmental social norms in the economy and the anticipation of future developments of climate regulation. |
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Fabio Braggion, Mintra Dwarkasing, Steven Ongena, Household inequality, entrepreneurial dynamism and corporate financing, In: Swiss Finance Institute Research Paper, No. 14-27, 2020. (Working Paper)
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Economic theories provide conflicting hypotheses on how wealth inequality affects entrepreneurial dynamism. To empirically investigate its impact, we construct local measures of household wealth inequality based on financial rents, home equity, and 1880 farmland. We identify its effects on entrepreneurship by instrumenting it with land distribution under the 1862 Homestead Act or US states’ removal of “death taxes”. Wealth inequality decreases firm entry and exit, and the proportion of high-tech businesses across metropolitan statistical areas. There is also less redistribution into public goods supportive of entrepreneurship such as schooling and the judiciary. Income per capita consequently grows more slowly. |
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Gianluca De Nard, Zhao Zhao, A Large-Dimensional Test for Cross-Sectional Anomalies: Efficient Sorting Revisited, In: SSRN, No. 3560178, 2020. (Working Paper)
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Many researchers seek factors that predict the cross-section of stock returns. In finance, the key is to replicate anomalies by long-short portfolios based on their factor scores, with microcaps alleviated via New York Stock Exchange (NYSE) breakpoints and value-weighted returns. In econometrics, the key is to include a covariance matrix estimator of stock returns for the (mimicking) portfolio construction. This paper marries these two strands of literature in order to test the zoo of cross-sectional anomalies by injecting size controls, basically NYSE breakpoints and value-weighted returns, into efficient sorting. Thus, we propose to use a covariance matrix estimator for ultra-high dimensions (up to 5,000) taking into account large, small and microcap stocks. We demonstrate that using a nonlinear shrinkage estimator of the covariance matrix substantially enhances the power of tests for cross-sectional anomalies: On average, ‘Student’ t-statistics more than double. |
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Gianluca De Nard, Simon Hediger, Markus Leippold, Subsampled Factor Models for Asset Pricing: The Rise of Vasa, In: SSRN, No. 3557957, 2020. (Working Paper)
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We propose a new method, VASA, based on variable subsample aggregation of model predictions for equity returns using a large-dimensional set of factors. To demonstrate the effectiveness, robustness, and dimension reduction power of VASA, we perform a comparative analysis between state-of-the-art machine learning algorithms. As a performance measure, we explore not only the global predictive but also the stock-specific R2's and their distribution. While the global R2 indicates the average forecasting accuracy, we find that high variability in the stock-specific R2's can be detrimental for the portfolio performance, due to the higher prediction risk. Since VASA shows minimal variability, portfolios formed on this method outperform the portfolios based on more complicated methods like random forests and neural nets. |
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Gianluca De Nard, Oops! I Shrunk the Sample Covariance Matrix Again: Blockbuster Meets Shrinkage, In: SSRN, No. 3400062, 2019. (Working Paper)
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Existing shrinkage techniques struggle to model the covariance matrix of asset returns in the presence of multiple-asset classes. Therefore, we introduce a Blockbuster shrinkage estimator that clusters the covariance matrix accordingly. Besides the definition and derivation of a new asymptotically optimal linear shrinkage estimator we propose an adaptive Blockbuster algorithm that clusters the covariance matrix even if the (number of) asset classes are unknown and change over time. It displays superior all-around performance on historical data against a variety of state-of-the-art linear shrinkage competitors. Additionally, we find that for small and medium-sized investment universes the proposed estimator outperforms even recent nonlinear shrinkage techniques. Hence, this new estimator can be used to deliver more efficient portfolio selection and detection of anomalies in the cross-section of asset returns. Furthermore, due to the general structure of the proposed Blockbuster shrinkage estimator the application is not restricted to financial problems. |
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Markus Leippold, Steven Schärer, Optimal Conic Execution Strategies with Stochastic Liquidity, In: SSRN, No. 3123033, 2018. (Working Paper)
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In this paper, we develop the conic finance framework for optimal execution of a large portfolio in an illiquid market. We extend the classical optimal execution results by considering stochastic exogenous liquidity effects as well as temporary price impact functions. We depart from the traditionally assumed linear impact function and introduce both stochastic liquidity and volatility effects and nonlinear temporary market impact. Moreover, we allow for an additional stochastic exogenous liquidity effect, used to capture the base illiquidity of a market. We analyze various aspects of our model using a stylized example. |
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Julian Kölbel, Markus Leippold, Jordy Rillaerts, Qian Wang, Does the CDS market reflect regulatory climate risk disclosures?, In: SSRN, No. 3616324, 2020. (Working Paper)
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Climate change may have a detrimental effect on a firm's financial performance. Using a forward-looking measure of climate risk exposure based on textual analysis of firms' 10-K reports, we assess whether climate risks---as disclosed to the regulator---are priced in the credit default swap (CDS) market. We construct this novel climate risk measure based on BERT, an advanced language understanding algorithm, and adapt it for our purpose. We differentiate between physical and transition risks and find that transition risk increases CDS spreads, especially after the Paris Climate Agreement of 2015. However, we do not find such an effect for physical risk. |
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Julia Meyer, Ola Elsayed, The Anatomy of Sustainability, In: SSRN, No. 3597700, 2020. (Working Paper)
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We present evidence that sustainability is inextricably linked with market-implied uncertainty and sentiment. We derive an econometric decomposition of sustainability ratings yielding three orthogonal components capturing uncertainty, investor sentiment, and an idiosyncratic sustainability factor. Examining the shock of the COVID-19 pandemic to the US stock market in light of these explanatory factors, we show that the perceived immunity of sustainable stocks during the crash is essentially driven through the uncertainty channel. Once controlling for uncertainty, sentiment and firm fundamentals, the positive relationship between idiosyncratic sustainability and resilience persists, albeit weakly. |
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