Knowledge that Transforms

In this paper we propose to measure the model risk of Expected Shortfall as the optimal correction needed to pass several ES backtests, and investigate the properties of our proposed measures of model risk from a regulatory perspective. Our results show that for the DJIA index, the smallest corrections are required for the ES estimates built using GARCH models. Furthermore, the 2.5% ES requires smaller corrections for model risk than the 1% VaR, which advocates the replacement of VaR with ES as recommended by the Basel Committee. Also, if the model risk of VaR is taken into account, then the corrections made to the ES estimates reduce by 50% on average.

We analyze the effect of a firm's innovation activities on its likelihood to be acquired and the takeover premium using a large sample of M&A transactions. We show that firms with larger innovation outputs and R&D investments are more likely to be acquired, receive unsolicited bids, and receive multiple bids. The takeover premium increases with the target firm's innovation output, and this positive relation is stronger when there are more competing bidders, when acquiring firms’ product markets are competitive, and when technological proximity is lower in the acquiring firms’ industry. Both the acquirer's cumulative abnormal return around the announcement date and post-acquisition operating performance are positively related to the target firm's innovation output and R&D spending.

Based on data from a representative survey among German private financial decision makers that comprised two stated choice experiments for fixed-interest investment products and equity funds, this paper empirically examines whether and which investors are willing to pay for sustainable investments. In fact, our econometric analyses with mixed and latent class logit models reveal strong stated preferences and a considerable willingness to pay (WTP) for sustainable investment products. Furthermore, our mixed logit model analysis implies that the mean WTP for certified sustainable investment products is strongly higher than the mean WTP for the uncertified counterparts. In addition, our estimation results suggest that investors with high feelings of warm glow from sustainable investments, an affinity to left-wing parties, and a strong environmental awareness have a clearly higher mean willingness to sacrifice returns for sustainable investment products than their counterparts. While risk perceptions seem to be additionally relevant for certified sustainable equity funds, they obviously play a negligible role for less risky sustainable fixed-interest investment products.

This paper investigates the role of credit risk in the relationship between short-selling activity and future stock returns. We find that the predictive power of short interest for future returns is concentrated in the worst-rated stocks. Low-grade stocks with the largest short interest decrease outperform those with the largest short interest increase by 1.09 percent in the following month. This return spread is robust to controls for cross-sectional effects and firm characteristics, and is much more pronounced during periods of high investor sentiment and low liquidity. Distressed firms with large short interest increases experience a worse performance subsequently.

We use the 2016 U.S. SEC tick size pilot to examine the effects of an increase in the minimum price variation on limit order book liquidity in NASDAQ-listed stocks on the NASDAQ exchange. For treatment stocks with an average pre-pilot quoted spread less than 0.05, the tick size increase is binding and leads to a significant decrease in liquidity in the limit order book. Specifically, the implied cost to trade at and away from the best bid and offer prices increases and the limit order book becomes less resilient – the amount of time required for a deviation in liquidity to return to its long-run mean. For treatment stocks with an average pre-pilot quoted spread of at least 0.05, the tick size increase is non-binding and leads to either a slight decrease, or no change in limit order book liquidity.

Over 26% of investment company assets are held in passively managed vehicles. Thus, it is important to understand what affects the performance of passive vehicles and how to choose among the multiple passive options following any index. This paper examines the factors that are important in explaining differences across funds following the same index and demonstrates how to select a passive vehicle that has a high probability of having the best performance in the following years.

This paper provides new insights on consumers payment choice by comparing cost of paying with cash to paying with cards. Our novel method accounts for how much change is received in the form of banknotes and metal coins, assuming that the weight and size of coins are inconvenient to carry. We use the regression discontinuity design approach to estimate the model using the 2013 Bank of Canada Method-of-Payments Survey and find a significant number of cash users who switch to paying with debit or credit cards at transaction values marginally above 5 and 10. We attribute this finding to the burden of receiving coins as change associated with the currency denomination structure. Our proposed methodology is general and can be applied to other countries and institutional details.

The model developed in this paper examines the interaction between monetary and macroprudential policies in promoting macroeconomic stability, highlighting the role of shocks and policy instruments. The paper shows that assigning the mandates of monetary and financial stability to independent authorities enhances macroeconomic stability only when some level of coordination exists between policymakers and it is the dominant institutional arrangement when monetary stability is socially important. Instead, when society values financial stability, internalising the policy spillovers by assigning the two mandates to a single policymaker could become the dominant configuration depending on the model’s parameter values.

This paper analyses the intraday liquidity management game played in large-value payment systems accounting for a variable and a fixed cost of liquidity. While the liquidity cost is a decisive factor for settlement behaviour, the availability of intraday liquidity until end-of-day matters too, as it mutes late settlement incentives originating from settlement risk. Whether liquidity is provided via overdraft or intraday credit hardly matters. A late settlement fee can both disincentivise settlement coordination or implement early settlement. Its calibration is usually non-trivial with the major exception of a fixed cost and end-of-day availability of intraday liquidity.

This paper introduces parametric spectrum estimation to the analysis of financial cycles. Our contribution is to formally test properties of financial cycles and to characterize their international interaction in the frequency domain. Existing work argues that the financial cycle is considerably longer in duration and larger in amplitude than the business cycle and that its distinguishing features became more pronounced over time. Also, a global cycle, being driven by US monetary policy, is said to be behind national financial cycles. We provide strong statistical evidence for the US and slightly weaker evidence for the UK validating the hypothesized features of the national financial cycle. In Germany, however, the financial cycle is much less visible. Similarly, a US-driven global financial cycle significantly affects national cycles in the UK but not in Germany.