CAFIN publishes nine new working papers

October 10, 2016

The Center for Analytical Finance (CAFIN) publishes nine new working papers on the website. Working papers 31, 32, 33, 34 and 36 were partially funded by CAFIN grants. Working paper 35 was authored by two CAFIN research affiliates. Working papers 28, 29, 30 were done by Wentao Su, a doctoral student in the Economics Department who used resources (access to Bloomberg terminal) provided by CAFIN.

The 28th working paper is “Determinants of Non-Performing Loans in China and the Ownership Effect” by Wentao Su.

The abstract reads: “This prospectus analyzes the potential determinants of Chinese non-performing loan (NPL) ratio in banking sector and its implications using panel data from different banks in China. By incorporating both bank specific factors and macro variables, it shows domestic credit growth rate, bank profitability measures and bank ownership play important roles in determining NPL ratio. Analysis of proportion of shares of different types of owners shows that increasing percentage of shares controlled by private institutional investors reduces the NPL ratio significantly. In addition, the declining quality of infrastructure loans indicates the side effect of Chinese economic stimulus plan of 2008, and explains the existing performance gap between Chinese state-owned banks and joint-equity banks. This prospectus discovers some evidence of growth disparity in three most prosperous regions in China where varied degrees of economic reform has led to different performance. By measuring IPO and foreign minority ownership event, it also finds the events of IPO and foreign minority ownership alone cannot improve the bank performance. China’s weak corporate governance needs an overhaul to deal with the nepotism towards state-owned enterprises (SOE) and state-owned banks (SOB), which fundamentally distorts the banking sector. Finally, the prospectus anticipates several lines of future research, like how SOE and SOB can be deinstitutionalized; what is the effect of the shadow banking system on financial stability and health; and whether a more developed equity market will help reduce the NPLs as firms have more financing tools to fund their business.” The working paper can be downloaded here.

“Underpricing, Institutional Investors and the JOBS Act” by Wentao Su is the 29th paper the center has published.

The abstract reads: “Underpricing in IPOs, which is the first day stock price return, is a significant cost to the issuers of raising capital. The money left on the table also attracts attention from different financial players such as institutional investors and big underwriters for its profits and commissions. This paper reviews two hypotheses for IPO underpricing, the general information asymmetry theory that ‘underpricing’ is a consequence of investors needing to be compensated for uncertainty about the quality of the firm, and the more practical underwriter-institutional investor collusion that may explain the increase in underpricing in recent years. By studying underpricing in the context of the JOBS Act, a natural policy experiment that significantly reduces IPO disclosure requirement and yet increases the communication between institutional investors and issuers, I find that the JOBS Act increases the overall IPO underpricing 18 months after it was passed in 2012 compared to the same period before, in line with the traditional adverse selection phenomenon. However, empirical analysis shows underpricing also increases correspondingly with the rise in proportional shares of institutional investors in post-Act period, which supports the collusion hypothesis. The overall conclusion shows strong side effect of JOBS Act in terms of increasing underpricing to issuers and as a result more lucrative underwriting business.” The working paper can be downloaded here.

“Private Equity Performance, Fund Size and Historical Investment” by Wentao Su is the 30th paper the center has published.

The abstract reads: “This paper discusses the performance pattern of US private equity fund from 2003 to 2013, measuring the effect of fund size and other fund characteristics as well as macroeconomic conditions on fund performance. The results shows that the number of historical investment decisively influences the performance of funds, and funds whose inception is at the peak of economic expansion seem to perform worse than those formed during other economic periods. Fund size effect is ambiguous in full sample specifications but appears to be concave with respect to return when we look at this relationship in segmentation. Overall, experience of investment plays an important role in continually improving the performance of the fund. More details of each investment within each fund are needed to further analyze the causality between fund total return, its investment characteristics and other unique factors.” The working paper can be downloaded here.

“Bayesian Stochastic Volatility Models for High-Frequency Data” by Georgi Dinolov, Abel Rodriguez, and Hongyun Wang is the 31st paper the center has published.

The abstract reads: “We formulate a discrete-time Bayesian stochastic volatility model for high-frequency stock-market data that directly accounts for microstructure noise, and outline a Markov chain Monte Carlo algorithm for parameter estimation. The methods described in this paper are designed to be coherent across all sampling timescales, with the goal of estimating the latent log-volatility signal from data collected at arbitrarily short sampling periods. In keeping with this goal, we carefully develop a method for eliciting priors. The empirical results derived from both simulated and real data show that directly accounting for microstructure in a state-space formulation allows for well-calibrated estimates of the log-volatility process driving prices.” The working paper can be downloaded here.

“Secondary Currency Acceptance: Experimental Evidence with a Dual Currency Search Model” by Justin D. Rietz is the 32nd paper the center has published.

The abstract reads: “I examine, in a controlled, experimental laboratory setting, the acceptance of a secondary currency when a primary currency already circulates in an economy. The underlying model is an indivisible good / indivisible money, dual currency search model similar to that in Kiyotaki and Wright (1993) and Craig and Waller (2000). In such models, there are two pure Nash equilibria - total acceptance or total rejection of the secondary currency - and one unstable, mixed equilibrium denoted as partial acceptance. This mixed equilibrium is considered an artifact of the indivisibility of money and goods in the model and is often ignored. I find that when barter between good holders is allowed, the equilibrium tends towards total rejection. Conversely, when barter is prohibited, the equilibrium tends towards total acceptance. However, in both cases, the economies as a whole display partial acceptance of the secondary currency.” The working paper can be downloaded here.

“Relative Spread and Price Discovery” by Eric M. Aldrich and Seung Lee is the 33rd paper the center has published.

The abstract reads: “We develop a theoretical model to highlight a previously unexplored mechanism of price discovery: relative minimum price increments for equivalent assets trading on distinct nancial exchanges. Although conventional wisdom dictates that futures market assets lead equities equivalents in terms of price formation, our model predicts that the opposite should be true when particular relative price conditions hold for the bids and offers of each asset. We develop a new empirical measure of price discovery which is suited to asynchronous, high-frequency transaction and quotation data, and apply it to the highly liquid E-mini/SPY pair in order to test the predictions of the model. Empirical evidence strongly supports the model and further demonstrates that relative minimum contract size plays an additional role in the formation of prices.” The working paper can be downloaded here.

“A Dynamic Model of Firm Valuation” by Natalia Lazzati and Amilcar A. Menichini is the 34th paper the center has published.

The abstract reads: "We propose a dynamic version of the dividend discount model, solve it in closed-form, and assess its empirical validity. The valuation method is tractable and can be easily implemented. We find that our model produces equity value forecasts that are, on average, very close to market prices, and explains a large proportion (around 83%) of the observed variation in share prices. Moreover, we find that a simple portfolio strategy based on the difference between market and estimated values earns considerably positive returns, on average. These returns are uncorrelated with the three risk factors in Fama and French (1993).” The working paper can be downloaded here.

“The Flash Crash: A New Deconstruction” by Eric M. Aldrich and Joseph A. Grundfest is the 35th paper the center has published.

The abstract reads: “The ‘Flash Crash’ of May 6th, 2010 comprised an unprecedented 1,000 point, five-minute decline in the Dow Jones Industrial Average that was followed by a rapid, disorderly recovery of prices. We illuminate the causes of this singular event with the first analysis that tracks the full order book activity at millisecond granularity. We document previously overlooked market data anomalies and establish that these anomalies Granger-caused liquidity withdrawal. We offer a simulation model that formalizes the process by which large sell orders, combined with widespread liquidity withdrawal, can generate Flash Crash-like events in the absence of fundamental information arrival.” The working paper can be downloaded here.

“Do Credit Rating Agencies Provide Valuable Information in Market Evaluation of Sovereign Default Risk?” by Mahir Binici and Michael Hutchison is the 36th paper the center has published.

The abstract reads: “This paper accesses the information value of the three largest credit rating agencies’ (CRA) announcements of sovereign credit rating changes, “outlook” changes and “watch” changes on market pricing of country default risk as embedded in credit default swap (CDS) spreads. A dynamic panel model is estimated with 56 advanced and emerging-market countries and monthly data over January 2004 through August 2012. This approach allows us to control for macroeconomic news in identifying the information value of the CRA announcements. We find marked asymmetries in market impact from watch and outlook designations; credit upgrades and downgrades; and across different CRA announcements. Credit rating downgrades and negative watch announcements have a large impact on CDS spreads even when controlling for macroeconomic and financial factors. Surprisingly, the effect of credit downgrades is substantially magnified if countries are placed on negative watch status prior to the credit rating change—presumably signaling rapidly deteriorating credit worthiness. Credit upgrades and positive watch/ outlook announcements, by contrast, have little impact on market prices. S&P and Fitch dominate Moody’s in terms of the impact of their credit announcements on CDS spreads. Negative CRA announcements have a large and persistent effect on the market perception of sovereign default risk, constituting important “news” to financial markets.” The working paper can be downloaded here.