Contributions in Merlin

Currency carry trade returns are on average large and non-normally distributed. While the literature has found different explanations for the existence of carry trade returns, the higher order moments of their return distribution still pose a puzzle. We propose a new model to explain these non-normal properties of currency carry trade returns, by assuming that agents are loss averse and overweight states with low probabilities. This combination of loss aversion and probability weighting is called crash-o-phobia. Using non-linear least squares and risk-neutral state prices implied by currency options, we estimate this crash-o-phobia model to price developed and emerging market currencies. The parameter estimates reveal crash-o-phobic beliefs and preferences with significant differences across currencies. Compared to a model with rational beliefs and CRRA utility, our crash-o-phobia model performs significantly better at explaining the whole distribution of currency carry trade returns.

Users’ data has become a crucial production factor for companies and a necessary asset if they are to compete in the digital ecosystem. However, users’ data is a production factor that is not mobile across companies, since a company can only use the data that its customers—its “users”— generate within its own environment and not the data that its users produce outside of it. This represents a market friction that hinders competition, leads to monopolies, and raises the entry barriers for new companies. Additionally, the users generating and owning the data stored in a company have no control over or overview of their data and cannot monetize it. We model the users’ data as a production factor in the value generation function of companies and introduce the concept of data elasticity of value. Further, and in light of advances in distributed database management, blockchain technology, and data protection regulation, we propose an information system that allows users to sell their data freely to companies other than those within which the data was generated, receiving a self-generated, market-driven basic income. A consequence of this system is that data becomes a mobile production factor, since any company can work with the data that its users generate outside of that company’s own environments. Moreover, our system solves some of the data- ownership problems of the current Internet business model, lowers the entry barriers for new data-intensive companies, and enables new income streams for data-intensive companies, which in the case of online platforms allows them to avoid a dependence on online advertisement to finance their operations. We propose this ecosystem at a conceptual level and simulate the impact of companies having access to higher fractions of their users’ data under different data elasticities of value. We show that the introduction of such a system could theoretically, and under the taken assumptions, more than double the aggregated value of data-intensive companies.

Diversification is a fundamental concept in economics, decision theory, and finance, but the way in which it is implemented in the real world varies greatly. This paper asks how elementary the notion of diversification is by studying whether children apply it as a choice heuristic. We report on results of an experiment that tests whether children diversify in a sequence of hypothetical choice questions and dice-rolling games. Overall, we find that children do exhibit preferences for diversification, both for the sake of variety across consumption goods and for the purpose of mitigating risk when faced with a choice across risky gambles. The naive diversification heuristic, which implies an equal allocation across alternatives, is particularly evident in children's choices when the alternatives are equivalent or unknown. We also investigate the relationship between risk aversion and diversification and find no significant connection between the two. Our results indicate that diversification preferences may have fundamental, developmental roots, which contrasts with the traditional normative view of diversification, in which most economic models take diversification preferences as exogenously given. This may have implications for how one can treat investment anomalies in practice and, in particular, promotes financial literacy training from a young age.

We document significant differences in the financing structure of small firms with managers of diverse cultural backgrounds. To isolate the effect of culture, we exploit cultural heterogeneity within a geographical area with shared regulations, institutions, and macroeconomic cycles. Our findings suggest that there exist significant cultural differences in the preference towards debt funding and in the use of formal and informal sources of financing (bank loans and trade credit). Our results are robust to alternative explanations based on potential differences in credit constraints and in the distribution of cultural origins across industries, trading partners, and headquarters location.

We use a dynamic framework to address the questions: i) when should an insurance firm pay out dividends and raise (costly) capital and ii) when should an insurance firm take (liquid) investment risk. Financial decisions are made by a manager who strives to maximize firm value and operates in the presence of financial frictions and regulatory capital constraints. We show there is a unique pricing measure that is consistent with market prices and a broad ownership base and use it to compute the risk-adjusted net present value of cash flows to shareholders. We describe the capital and dividend strategies of the firm and show that, from a shareholder perspective, investment in risky assets can be value adding. Risky investments may add value by boosting the value of the option to default or, sometimes, by increasing the firm's franchise value.

What is beautiful is good, the ancient Greek lyric poet Sappho wrote over 2,500 years ago. Studies in social sciences, anthropology, psychology, and economics have shown various effects of physical attractiveness. Physically attractive people are hired more often, receive faster promotion, and generally earn more per hour; thus, there is a beauty premium. However, within the context of sports, little is known about consumer preferences concerning athletes’ physical attractiveness. In this study, we analyze 622 live tennis matches from 66 Grand Slam tournaments between 2000 and 2016, examining the relationship between attractiveness, measured by tennis players’ facial symmetry, and TV-viewership. We show that facial symmetry plays a positive role for female matches while there is no significant effect for male matches. The effect persists in several sub-sample regressions and robustness checks. Our results have important implications for managers in the field of sports. TV-broadcasters will likely acknowledge additional revenue potential from advertising due to increased viewership and change their programming accordingly. We contribute to the sports management and economics literature in that we introduce a new method to measure facial symmetry and show that physical attractiveness plays a positive role in tennis TV-viewership.

Using a unique data set of business loan applications to a single bank from individuals who are majority owners of small firms, we study how bank credit origination or denial affects individuals' income. The bank cutoff rule based on the applicants' credit score creates a sharp discontinuity in the decision to originate loans or not. We show that loan origination increases recipients' income five years onward by more than 10% compared to denied applicants. The effect is more pronounced in rural and low-income areas. Our results suggest an important role for banks` credit decisions on the distribution of income.

Model risk needs to be recognized and accounted for in addition to market risk. Uncertainty in risk measures estimates may lead to false security in financial markets. We argue that quantile type risk-measures are at least as good as expected shortfall. We demonstrate how a bank can choose among competing models for measuring market risk and account for model risk. Some BCBS capital requirements formula currently in effect leads to excessive capital buffers even on an unstressed basis. We highlight that the loss to society associated with the inefficient minimum capital requirements calculations is economically substantial over time.

Does neglecting the possibility that fossil fuel reserves become “stranded” result in a "carbon bubble", i.e., an overvaluation of fossil fuel firms? To address this question, we study whether banks price the climate policy risk. We hand collect global data on corporate fossil fuel reserves, match it with syndicated loans, and subsequently compare the loan rate charged to fossil fuel firms-along their climate policy exposure-to non-fossil fuel firms. We find that before 2015 banks did not price climate policy risk. After 2015, however, the risk is priced, especially for firms holding more fossil fuel reserves. We also provide some evidence that "green banks" charge marginally higher loan rates to fossil fuel firms.