Note from the Director
The last year has been a tumultuous one for CAFIN, even before the ongoing pandemic. The conference, Exchange Rates and Macroeconomic Policies – Recent Developments, scheduled for December 2-3 2019, and co-organized with our host, the Global Research Unit, Department of Economics & Finance, City University of Hong Kong (CUHK), as well as the Institute of Empirical Economic Research, Osnabrück University, Germany, had to be postponed at the last minute because of political unrest in Hong Kong. The conference was meant to address multiple issues that have become more salient with continued globalization and ongoing threats to financial stability. At the time, it seemed that the factors leading to the postponement were orthogonal to its focus, but subsequent events have suggested that a key point made at the Fall 2018 CAFIN panel, which looked back at the 2008 financial crisis on its tenth anniversary, is alarmingly true: future risks to the global economy would lie in new and unexpected places.
Following up on our 2018 panel, CAFIN planned a full-day workshop on Finance in the 2020s: Innovation, Risk and Inclusion, which was to be held March 13-14, 2020 at UC 
Santa Cruz. The schedule featured panels on global financial risks, financial market design, and financial inclusion, as well as keynote talks by Jagdeep Singh Bachher, the Chief Investment Officer and Vice President of Investments for the University of California, and June Ou, Chief Operating Officer and Co-Founder of Figure Technologies, Inc, who is an alumna of UCSC and a serial FinTech entrepreneur. Panelists and other speakers included several CAFIN Research Affiliates among an array of prominent academics and practitioners 
(Elena Asparouhova, Professor of Finance at the University of Utah; Peter Cramton, Professor of Economics at the University of Cologne, Ingrid Werner, Professor of Finance at The Ohio State University; Sanjiv Das, Professor of Finance and Business Analytics at Santa Clara University; Terrance Odean, Professor of Finance at UC Berkeley; Ratna Sahay, Deputy Director of the Monetary and Capital Markets Department at the International Monetary Fund; Galina Hale, Professor of Economics at UCSC; Barry Eichengreen, Professor of Economics at UC Berkeley; Laura Kodres, Distinguished Senior Fellow at MIT; Christine Parlour, Professor of Finance at UC Berkeley; Gurnain Pasricha, Senior Financial Sector Expert at the IMF; and Vladyslav Sushko, Senior Economist, Office for Asia and the Pacific, Bank for International Settlements).
The workshop had received generous support from the University of California Office of the CIO, which allowed us to invite and host other UC faculty and graduate students to participate. Tickets were bought, hotel rooms reserved and everything meticulously planned, but a few days before the event, with health and safety in mind, we bowed to the inevitable and postponed the workshop, even though it was a relatively small gathering. Five days later, Santa Cruz County joined the San Francisco Bay Area in announcing a shelter-in-place order, the whole state followed three days after that, and many weeks later, we are looking at a world with massive new uncertainties and risks.
The economic shock of the pandemic did reveal that some lessons had been learned from the financial crisis. Monetary authorities have responded much more quickly than they did in 2008, in this case to mitigate the financial fallout of the lockdown of the economy. But the public health and other behavioral responses have been more challenged, and we will experience the structural impacts of the pandemic for some time to come. Meanwhile, financial issues will not go away, and systemic risks, the workings of financial markets, and inequalities in financial access will continue to be important, but on an altered playing field. Once there is a sense of some return to a new normal, CAFIN will reschedule its workshop, perhaps modified to take account of the changes wrought by the pandemic. We still believe in our original vision of a small in-person gathering to allow for thoughtful interactions, and have resisted the rush to switch completely to a world of virtual intellectual exchange. Meanwhile, of course, there is a sufficient supply of instant analyses of the economic impacts of the virus. For now, we wish all our readers and supporters a safe, healthy and comfortable few months ahead, and look forward to the day when we can welcome you to UC Santa Cruz and its beautiful natural setting.
CAFIN and COVID-19
UCSC’s Kristian López Vargas, a CAFIN Research affiliate, has led the effort in developing, along with the Peruviangovernment and a global team of researchers, an app to improve "contact tracing" and protect people from COVID-19 in Peru. The app was launched as early as April 3, and quickly gained over a million users. The full story can be found here.
The University of Cologne’s Peter Cramton, also a CAFIN Research Affiliate, has been working on a project with fellow market design pioneers Axel Ockenfels, Alvin E. Roth, and Robert B. Wilson, to “Harness technology and market design principles to improve the allocation of critical coronavirus resources.” Their initial research is summarized in a paper, Market Design to Save Lives, available here.
CAFIN Special Seminar
Urjit Patel: The cul-de-sac in Indian Banking – A dominant government sector, limited fiscal space and independent regulation (Is there an 'impossible trilemma’?), June 2019
(This event was co-sponsored with the UCSC Department of Economics)
Dr. Urjit Patel served as the Governor of the Reserve Bank of India (India’s central bank) from 2016 through 2018 and as Deputy Governor from 2013 to 2016. Dr. Patel is an expert on monetary policy and financial sector reform. In 2014, he chaired an expert panel to revise and strengthen the monetary policy framework of the Reserve Bank. The final report proposed the inflation-targeting framework implemented by the RBI in 2016. He received his PhD from Yale University and began his career at the International Monetary Fund.
In the seminar, Dr. Patel gave an overview of the recent evolution and performance of the banking sector in India. He delved deeper into the proximate cause of a sharp rise in Non-Performing Assets (NPAs) in the banking system. NPAs in the Indian banking system have become a great potential source of financial sector instability for some years now. Dr. Patel noted the causes of the sharp rise in NPAs over the last decade by providing the contrast between government-owned banks and private banks. The issue of NPAs has largely been driven by the government-owned banks. Although government-owned banks are losing share to private banks, they still account for around 2/3 of total assets of the sector. Dr. Patel shed light on shortcomings in the system (including the government as well as regulatory institutions) and provided a summary of the regulatory and policy response to this crisis. The policy response followed an 8-R approach; namely, Recognize, Record, Report, Recovery, Resolution, Reinforced regulation, Recapitalization and Reform. Dr. Patel provided a detailed view of the empirical outcomes, as well as implications of this approach. Towards this end, he discussed the deeper problems that continue to abound for the Indian economy, such as an aggravated form of moral hazard, risk management, and especially, the trilemma faced by the government as well as the regulator. The trilemma is that it is not possible to (i) have dominance of government-owned banks in the banking sector; (ii) retain independent regulation; and (iii) adhere to public debt-GDP targets. In his concluding remarks, Dr. Patel noted that some headway has been made in addressing the NPA challenge in India in the last 5 years. However, he emphasized the need to continue regulatory forbearance, as well as execution of important reforms, to overcome the challenges.
(Director’s Note: The pre-existing condition of India’s financial sector, as detailed so effectively by Dr. Patel, has created additional challenges for the country’s response to the pandemic. If anything, the issues highlighted by Dr. Patel in this talk are even more important now than they were a year ago.)
Other Events
Conference: Recent Advances in Theoretical Corporate Finance and Firm Risk
On April 19, 2019, CAFIN organized a workshop on recent advances in theoretical 
corporate finance and firm risk.The objective of the workshop was to gather finance researchers with related work on how firm decisions and financial markets interact to determine optimal leverage and the maturity of debt. During the conference, the speakers provided new insights on how firms jointly choose optimal debt ratios and debt maturity, as well as how some of the anomalies observed in the data can be rationalized. The conference was co-organized by CAFIN Steering Committee member Natalia Lazzati, CAFIN Research Affiliate Amilcar Menichini, and Yuri Tserlukevich of Arizona State University.
Professor Hayne Leland, of the Haas School of Business at UC Berkeley, gave the keynote talk, in which he showed how structural models of the firm can be used to study the choice of optimal debt ratios and maturity. His earlier seminal work in this area was referenced throughout the conference. Alejandro Rivera (UT Dallas) analyzed dynamic contracts at the firm level where the manager chooses from short-term and long-term efforts while equity-holders select optimal leverage and the default policies. Interestingly, the short-termism is often more efficient for firm management. Francesca Zucchi (Board of Governors of the Federal Reserve System) used a structural model of the firm to show how the term of the debt affects shareholder behavior, suggesting that short-term debt might provide incentives for increasing asset risk. She demonstrated a “rollover trap” effect, when the extra burden of retiring debt can lead to distress.
Yuri Tserlukevich and Oliver Boguth (Arizona State University) explained how strategic interactions among firms impact their systematic risk, showing that, in general, competition diminishes systematic risk and reduces asset pricing anomalies regarding firm size. Their work showed that the number of competitors in the industry is an insufficient, and often irrelevant, statistic. Zhiyao (Nicholas) Chen (Chinese University of Hong Kong) showed how two very well-known contradicting puzzles, such as the negative failure probability-return relation and the positive distress risk-return relation, can be rationalized with a structural model of the firm. Patrick Weiss (Vienna Graduate School of Finance) and Maria Chaderina (Vienna University of Economics and Business) described how the choice of debt maturity might affect asset pricing, showing that firms with longer maturity of debt have betas that co-vary more with the market price of risk. Finally, Maria Bustamante (University of Maryland) used a real options model to characterize how vertical strategic interactions (i.e., firms with their customers and suppliers) affect asset prices.
CAFIN Lectures
Siddhartha Chib: On Comparing Asset Pricing Models (May 2019)
Siddhartha Chib is Harry C. Hartkopf Professor of Econometrics and Statistics at Olin Business School, Washington University in St. Louis. His research is in the area of Bayesian statistics and Markov chain Monte Carlo computational methods. He is a Fellow of the American Statistical Association and the International Society of Bayesian Analysis. He directs the annual NBER-NSF sponsored Seminar in Bayesian Econometrics and Statistics, which features presentations by young and established researchers working on the theory and application of Bayesian methods.
In his lecture, Prof. Chib provided an introduction to the existing theory behind the sources of risk affecting assets in the financial markets. A fundamental goal of theoretical and empirical finance is to explain and measure the risk premium (the difference between the expected return of the asset and the risk-free return) for the cross-section of traded assets in financial markets. According to the factor theory of asset pricing, financial assets earn a risk-premium because the returns on those assets are systematically related to the underlying pricing factors. Such factors are called risk factors and represent sources of systematic risk affecting all assets. Recent research has focused on developing a Bayesian approach for finding such risk factors. Prof. Chib pointed out that the Bayesian marginal-likelihood-based model comparison method is unsound and cannot be used to locate the risk factors. He established this point with theoretical arguments and empirical evidence. Additionally, he showed how this problem can be done correctly by demonstrating a reliable way to select which factors are risk factors in asset pricing models.
Susan Thomas: When do regulatory interventions work? (Oct 2019)
Susan Thomas heads the Finance Research Group at the Indira Gandhi Institute for Development Research, Mumbai, India. Her primary research interest is in financial econometrics and market microstructure. Her recent research has focused on behavior choices in household finance, the design of bankruptcy law on the credit processes and credit markets, and behavioral choices in household finance.
Regulators worldwide have started to introduce measures like a fee on high order-to-trade ratio (OTR) to slow down high frequency trading. Previous studies on the OTR fee find mixed results about its impact on market quality. In her lecture, Prof. Thomas presented her study on a natural experiment in the Indian stock market where such a fee was introduced twice with subtle variations in the implementation being driven by varying motivations. Using a difference-in-difference regression that exploits microstructure features, she found that causal evidence of lower aggregate OTR and higher market quality when the fee was used to manage limited exchange infrastructure but little to no change in either OTR or market quality when it was used for a regulatory need to slow down high frequency trading.
Vojislav Maksimovic: The Rise of Star Firms: Intangible Capital and Competition (Nov 2019)
Vojislav "Max" Maksimovic is the William A. Longbrake Chair in Finance & Professor of Finance at the Robert H. Smith School of Business, University of Maryland. His recent research focuses on how a firm's organizational structure affects the flow of resources across its divisions. He has also worked on how competition in high technology industries determines the timing of initial public offerings, and how a country's legal and institutional environment influences the financing and investment by firms. He is an associate editor of Journal of Financial Intermediation and a past member of the board of directors of the Western Finance Association.
Prof. Maksimovic explained the motivation of his research in terms of a divergence in the returns of top-performing firms and the rest of the economy, especially in industries that rely on a skilled labor force, raising concerns about their market power. He then showed that the divergence is explained by the mismeasurement of intangible capital. He argued that star firms produce more per dollar of invested capital, have higher growth, innovation, and productivity, and are not affected differently by exogenous competitive shocks than other firms. Their pricing power supports their high intangible capital investment. Further, he warned that some exceptional firms may pose concerns due to their potential to foreclose competition in the future.
Financial Education
Personal Finance Course
In previous newsletters, we described a course on Personal Finance and Investing that had been 
developed by UCSC alum and lecturer Patricia Kelly. With support from the UC Office of the President, CAFIN, and UCSC’s Online Education office, an online version of this class was also developed and successfully launched. UCSC Online Education Director Michael Tassio has provided the following update and assessment.
“The online course Personal Finance and Investing, created by UCSC alum and lecturer Patricia Kelly, is a course that appeals to students because it teaches them practical life skills of managing their finances, and explaining the oft-intimidating financial concepts in simple and immediately applicable ways. From learning how to read bank statements and fill out tax forms, to understanding credit scores and trading in a stock market simulation — students in this course gain knowledge that can help them, and their families, navigate their everyday financial situations with more competence and confidence. The online version was first offered in the summer of 2019, when it enrolled 133 students. It was again offered in winter 2020, where it was opened to enrollment for any UC student, regardless of their campus affiliation. That offering hit the enrollment cap of 300 students, including those from the Santa Barbara, Davis, Riverside, and Irvine campuses. The course remains popular, and the next offering in Summer 2020 is expected to enroll around 300 UC Santa Cruz students. In recognition that there is great potential for the course to provide benefit to all UC employees, Lecturer Kelly and the course development team are considering options to release a new version of the course for faculty and staff on all UC campuses.”
CAFIN Supported Projects
Financial Market Design
Building on what was learned from a very simple setup explored earlier (in the published paper by Aldrich and 
López Vargas), Prof. Daniel Friedman and Prof. Kristian López Vargas, both affiliated with CAFIN, constructed a new and richer laboratory environment for studying high frequency trading (HFT). In this new environment, human subjects control and tune trading algorithms with inputs similar to those in today's major financial exchanges. The algorithms react (with tuned sensitivity) to trade flows observed in a remote market, to order book imbalances, and to the buildup of their own inventories. Traders also have access to different communication technologies. The authors have rebuilt the experimental software using an augmented instance of oTree to allow for real-time interactions. Along with the new human subject software and exchange processing modules, they have also built a Financial Market Simulator to find useful scenarios and candidate equilibria. This simulator runs in UCSC's Hummingbird supercomputer, crunching numbers for tens of thousands of simulated trading days per round.
Investor Attention and Asset Pricing
In an ongoing project, CAFIN Research Affiliate Prof. Grace Weishi Gu, along with a co-author, is examining how changes in investor attention affect asset prices. They use Bloomberg News-Heat Data to measure institutional investor attention to stocks and bonds. More specifically, the Bloomberg data tracks the number of Bloomberg news story publications on companies and sovereigns that issue bonds and/or equities, as well as Bloomberg users’ news reading and news searching activities on the terminals. By using equity returns, bond spreads, ratings, and some corporate characteristics through the Bloomberg terminal, the authors show that bond investors’ attention tends to rise when the sovereigns/companies they invest in are distressed, and the increased attention raises the bonds’ spread volatility. Currently, the authors are studying investor's attention to equities and resulting impacts on equity returns.
Decentralized Markets
UCSC graduate students Jason Vranek (Computer Science) and Yilin Li (Economics) had their paper "Decentralized Markets Evaluating Uniform and Non-Uniform Prices" accepted by the Third International Symposium on Foundations and Applications of Blockchain 2020. The paper uses simulations to compare different ways of implementing financial exchanges via blockchain to promote decentralization. Jason’s and Yilin’s work has been indirectly supported by CAFIN.
Bloomberg Terminal
UCSC students and faculty continue to benefit from the availability of a Bloomberg
terminal in the department, thanks to the donation of a license by Cabezon Investment Group (a company co-founded by UCSC alumni Michael Cagney and June Ou). Prof. Grace Gu, whose research was described above, notes that “Without the Bloomberg terminal, this research project would not have been feasible.” In another project, doctoral students Yunxiao Zhang, Yifei Sheng and Zijing Zhu are using data from the Bloomberg terminal to analyze news effects on crude oil future prices. The researchers have collected Bloomberg editorial news and web news on the topic of crude oil, as well as high-frequency intraday crude oil futures trading prices, from the terminal.
Acknowledgments
CAFIN wishes to acknowledge the generous support of 
Professor Katharyne Mitchell, Dean of the Division of Social Sciences at UCSC, and the assistance of her staff, including Pamela Dewey and Joni White, who have helped manage our website and our events, respectively. Economics doctoral students Prateek Arora and Gregory Klevans assisted in the preparation of this newsletter.
