Inaugural CAFIN Workshop Paper Presentations (2014)

Listed below are the abstracts of the papers to be presented at the Inaugural CAFIN Workshop.

International Coordination in Addressing Spillovers: Problems and Solution Strategies
The G-20 requires mechanisms for surveillance to measure and monitor risks arising from spillovers of Unconventional Monetary Policies. In this role, the G-20 should promote regulatory changes that help to monitor and reduce systemic risk emerging from the spillovers at the national level. A second area of work is financial data reporting standards, especially for firms that operate across boundaries. This would be supported by protocols and data management systems at the national level, and frameworks for cooperation and sharing of regulatory information to measure and contain risks at the international level.

“Near-Coincident” Indicators of Systemic Stress
Ivailo Arsov (IMF), Elie Canetti (IMF), Laura Kodres (IMF), and Srobona Mitra (IMF); Systemic Risk
The G-20 Data Gaps Initiative has called for the IMF to develop standard measures of tail risk, which we identify in this paper with systemic risk. To understand the conditions under which tail risk is present, it is first necessary to develop a measure of what constitutes a systemic stress, or tail, event. We develop such a measure and uses it to assess the performance of eleven near-term systemic risk indicators as ‘early’ warning of distress among top financial institutions in the United States and the euro area. Two indicators perform particularly well in both regions, and a couple of other simple indicators do well across a number of criteria. We also find that the sizes of institutions do not necessarily correspond with their contribution to spillover risk. Some practical guidance for policies is provided. 

International Evidence on Bank Funding Profiles and Performance: Are Banks “Overbanked”?
Jose A. Lopez (FRBSF) and Mark Spiegel (FRBSF); Systemic Risk
We investigate the implications of bank funding and lending strategies for bank performance using a large cross-country data set of individual bank outcomes. We find that increases in a bank’s reliance on deposits have adverse implications for its performance as measured by returns on assets. However, we also find evidence for positive spillovers for performances from being in a national banking system where other banks have greater overall funding stability, as measured by the Bank for International Settlements’ net-stable-funding-ratio, as well as when other banks hold more liquid asset portfolios, as measured by their cash share. Our results suggest that individual bank profitability is reduced by increased reliance on deposit funding, but those losses may be mitigated by the benefits of membership in a more stable national banking system.

Measuring Investors’ Risk Appetite in Emerging Markets
Fatih Kiraz (Central Securities Depository of Turkey) and Emrah Sener (Özyeğin University); Systemic Risk
Abstract coming soon.

Competing on Speed
Emiliano Pagnotta (NYU Stern) and Thomas Philippon (NYU Stern); Market Design
Technologies that accelerate transaction speed have reshaped securities, FX, and derivatives markets. The trading landscape has become more fragmented. We analyze these evolutions in a model where trading venues invest in speed technologies and compete for investors who choose where and how much to trade. Faster venues charge higher fees and attract speed-sensitive investors. Competition among venues increases investor participation, volumes, and allocative efficiency but can lead to socially excessive levels of speed. Regulations that protect transaction prices (e.g. SEC’s trade-through) lead to more fragmentation and faster speeds, but may reduce welfare. Independently of technology and entry costs, the optimal design has a single operating venue. Our model sheds light on the experience of European and U.S. markets since the implementation of MiFID and Reg NMS.

The Offshore Renminbi Exchange Rate: Microstructure and Links to the Onshore Market
Yin-Wong Cheung (City University Hong Kong) and Dagfinn Rime (Norges Bank and BI Norwegian Business School); Market Design
The offshore renminbi (CNH) exchange rate is the exchange rate of the Chinese currency transacted outside China. We study the CNH exchange rate dynamics and its links with onshore exchange rates. Using a specialized microstructure dataset, we find that CNH is significantly affected by its order flow, a measure of net buying demand. The offshore CNH exchange rate has an increasing impact on the onshore rate, and significant predictive power for the official RMB central parity rate. The CNH order flow also affects the onshore RMB exchange rate and the central parity rate.

The High-Frequency Trading Arms Race: Frequent Batch Auctions as a Market Design Response
Peter Cramton (University of Maryland), Eric Budish (Chicago Booth) and John Shim (Chicago Booth); Market Design
We argue that the continuous limit order book is a flawed market design and propose that financial exchanges instead use frequent batch auctions: uniform-price sealed-bid double auctions conducted at frequent but discrete time intervals, e.g., every 1 second. Our argument has four parts. First, we use millisecond-level direct-feed data from exchanges to show that the continuous limit order book market design does not really “work” in continuous time: market correlations completely break down at high-frequency time horizons. Second, we show that this correlation breakdown creates frequent technical arbitrage opportunities, available to whomever is fastest, which in turn creates an arms race to exploit such opportunities. Third, we develop a simple new theory model motivated by these empirical facts. The model shows that the arms race is not only socially wasteful — a prisoner’s dilemma built directly into the market design — but moreover that its cost is ultimately borne by investors via wider spreads and thinner markets. Last, we show that frequent batch auctions eliminate the arms race, both because they reduce the value of tiny speed advantages and because they transform competition on speed into competition on price. Consequently, frequent batch auctions lead to narrower spreads, deeper markets, and increased social welfare.

Credit Rationing in Informal Markets: The Case of Small Firms in India
Sankar De (Shiv Nadar University) and Manpreet Singh (Hong Kong University of Science and Technology); Financial Access
Using a unique dataset combining panel data of reported financial information for a sample of small and medium enterprises in India with data from a survey of the same firms regarding the role of relationships in supply of inter-firm credit, the present study examines the availability and importance of relationship-based informal credit for small firms given their total credit needs. We find that the firms that are unsuccessful in generating internal funds or bank loans appear to have better access to relationship-based credit. However, we also find persistent evidence of rationing of relationship-based credit, including credit driven by business relationships as well as social relationships. All firms in our sample face an upward-sloping credit supply function, while firms with limited collaterizable assets face an interest-inelastic supply curve. Though relationships mitigate information asymmetry problems between borrowers and lenders, our investigations suggest that moral hazard concerns still constrain credit supply. Credit providers decline credit when the interest rate reaches a critically high level and the heavy debt repayment obligations limit the borrowers’ stake in the debt-financed projects. This is the first study to document rationing of informal credit. Our findings have important research and policy implications

Do firms in developing countries grow as they age?
Meghana Ayyagari (School of Business, George Washington University), Asli Demirgüç-Kunt (World Bank) and Vojislav Maksimovic (Robert H. Smith School of Business, University of Maryland); Financial Access
We examine the relation between establishment size and age in the formal sector using survey data from 120 developing countries. Existing research suggests that manufacturing establishments in developing countries do not grow over time, most likely due to market imperfections and regulations. To the contrary, we find that the average plant in developing countries that is over 40 years old employs almost five times as many workers as the average plant five years or younger. We find consistent evidence when we look within a large country, India, using detailed manufacturing census data over 23 years. We also find that differences in financial development across Indian states, while substantial, have a minor effect on firm growth, consistent with inefficiency of state-owned financial systems. These results hold controlling for differences in labor regulations across states, capital intensity, labor regulations, and for firms born before and after the major reforms.

Do Retail Traders Suffer from High Frequency Traders?
Katya Malinova (University of Toronto), Andreas Park (University of Toronto), and Ryan Riordan (University of Ontario Institute of Technology) ; Financial Access
Using a change in regulatory fees in Canada in April 2012 that affected high-frequency quote submissions and cancellations, we analyze the causal impact of algorithmic trading activities on the trading costs and intraday returns of retail and institutional traders. Following the change, the number of trades, quotes, and cancellations dropped by 30% and market-wide bid-ask spreads rose by 9%. Trading costs for market orders, measured by bid-ask spreads, increased for institutions, but remained unaffected for retail traders. Both groups incur higher adverse selection costs on their limit orders. Retail traders’ intraday returns, especially from limit orders, declined, while institutions’ returns from market orders increased.