European Financial Management 2023 Archive

January 2023, VOL 29:1 March 2023, VoL 29:2 June 2023, VoL 29:3

European Financial Management, VOL 29:1, January 2023

Menu simplification for portfolio selection under short‐sales constraints

Farid AitSahlia, Thomas Doellman and Sabuhi Sardarli.

We introduce a risk‐reduction‐based procedure to identify a subset of funds with a resulting opportunity set that is at least as good as the original menu when short‐sales are imposed. Relying on Wald tests for mean‐variancespanning, we show that the better results for the subset can be explained by a higher concentration of covariance entries between its assets, ultimately leading to smaller Frobenius norms of the associated matrices. With data on US‐defined contribution plans, where participants have limited financial literacy, tend to be overwhelmed and prefer to make decisions among fewer choices, we obtain a 75% average reduction.

Keywords: asset allocation, defined contribution plans, mean‐variance spanning, short sales, Wald test

JEL Classification:

G11, G20, G23

Forecasting high-frequency excess stock returns via data analytics and machine learning

Erdinc Akyildirim, Duc Khuong Nguyen, Ahmet Sensoy, Mario Šikić.

Borsa Istanbul introduced data analytics to present additional information about its market conditions. We examine whether this product can be utilized via various machine learning methods to predict intraday excess returns. Accordingly, these analytics provide significant prediction ratios above 50% with ideal profit ratios that can reach up to 33%. Among all the methods considered, XGBoost (logistic regression) performs better in predicting excess returns in the long-term analysis (short-term analysis). Results provide evidence for the benefits of both the analytics and the machine learning methods and raise further discussion on the semistrong market efficiency.

Keywords: big data, data analytics, efficient market hypothesis, forecasting, machine learning.

JEL Classification:

C52, C53, D81, G14, G17.

Time series reversal in trend-following strategies.

Jiadong Liu, Fotis Papailias

This paper empirically studies the reversal pattern following the formation of trend-following signals in the time series context. This reversal pattern is statistically significant and usually occurs between 12 and 24 months after the formation of trend-following signals. Employing a universe of 55 liquid futures, we find that instruments with sell signals in the trend-following portfolio (‘losers’) contribute to this type of reversal, even if their profits are not realised. The instruments with buy signals in the trend-following portfolio (‘winners’) contribute much less. A double-sorted investment strategy based on both return continuation and reversal yields to portfolio gains which are significantly higher than that of the corresponding trend-following strategy.

Keywords: market timing, return signal momentum, reversal, time series momentum, trend‐following strategies.

JEL Classification:

Impact of MiFID II tick-size regime on equity markets—Evidence from the LSE

Eros Favaretto, Andrew Lepone, Grace Lepone.

This study investigates the impact of MiFID II on the London Stock Exchange. We find that a tick-size reduction leads to lower bid–ask spreads, lower trade values, reduced cost of trading at and beyond the best bid-offer, an acceleration of quote updates, an increase in aggressive trades and a reduction in price impact. Increased tick size widens spreads and increases trading costs. Step functions reveal that liquidity adjusts opposite to the tick change. To determine if impacts are proportional, we identify potential functions that predict cost changes with tick updates, implying that traders adjust their trade sizes according to the new tick levels.

Keywords: MiFID II, resiliency, tick size, trading cost

JEL Classification:

Are cryptocurrencies homogeneous?

Elias Bengtsson, Frida Gustafsson.

This article investigates if cryptocurrencies returns' are similarly affected by a selection of demand- and supply-side determinants. Homogeneity among cryptocurrencies is tested via a least absolute shrinkage and selection operator (LASSO) model where determinants of Bitcoin returns are applied to a sample of 12 cryptocurrencies. The analysis goes beyond existing research by simultaneously covering different periods and design choices of cryptocurrencies. The results show that cryptocurrencies are heterogeneous, apart from some similarities in the impact of technical determinants and cybercrime. The cryptocurrency market displays evidence of substitution effects, and design choices related explain the impact of the determinants of return.

Keywords: bitcoin, cryptocurrencies, decentralised virtual currencies,homogeneity, LASSO

JEL Classification: E42, G12

Flexibility in share repurchases: Evidence from UK

Manoj Kulchania, Rohit Sonika.

Although firms cite flexibility as important when repurchasing shares, we know little about how or why firms vary repurchases. We use an extensive sample of daily repurchase transactions from the United Kingdom to investigate how the number of repurchase days and volumes of shares repurchased change based on several known motivations. We find that stock price changes, liquidity, leverage, takeover activity and earnings per share targets impact share repurchasing patterns. Further, we compare actual repurchases to alternative share accumulation strategies and find that firms utilize flexibility without paying higher costs.

Keywords: flexibility, market timing, payout, repurchases, UK

JEL Classification: G35

Orderbook demand for corporate bonds.

Arthur Krebbers, Andrew Marshall, Patrick McColgan, Biwesh Neupane

We examine the determinants of investor demand for corporate bond offerings using novel data on the primary market orderbook size. We find that credit risk and bond market presence are significant in explaining investor demand. These effects are more pronounced during the crisis periods including the global financial crisis and eurozone crisis as well as during the postcrisis periods. Our results also highlight the size of the bond investor order depends on information asymmetry costs and the benefit of diversifications, as investor demand is lower for new issuers as well as very frequent issuers. The levels of investor demand have important economic consequences for bond issuers as high investor demand shortens the time to subsequent bond issues and potentially reduces the firm's cost of capital at issuance.

Keywords:bond pricing, investor demand, orderbook size, oversubscription.

JEL Classification:

G11, G12, G24.

Unravelling the JPMorgan spoofing case using particle physics visualization methods.

Philippe Debie, Cornelis Gardebroek, Stephan Hageboeck, Paul van Leeuwen, Lorenzo Moneta, Axel Naumann, Joost M. E. Pennings, Andres A. Trujillo-Barrera, Marjolein E. Verhulst.

On 29 September 2020, JPMorgan was ordered to pay a settlement of $920.2 million for spoofing the metals and Treasury futures markets from 2008 to 2016. We examine these cases using a visualization method developed in particle physics (CERN) and the messages that the exchange receives about market activity rather than time-based snapshots. This approach allows to examine multiple indicators related to market manipulation and complement existing research methods, thereby enhancing the identification and understanding of, as well as the motivation for, market manipulation. In the JPMorgan cases, we offer an alternative motivation for spoofing than moving the price.

Keywords:high‐frequency trading, limit order book, particle physics, spoofing, visualization.

JEL Classification:

G10, G18, G23, G28, K22, K23.

Trade credit in Europe: Financial constraint and substitution effect in crisis times.

Candida Bussoli, Claudio Giannotti, Francesca Marino, Antonello Maruotti.

This paper aims to prove whether financial rationing condition leads European enterprises to increase trade debt during the period 2008–2016 and whether companies offering deferred payments to customers obtain trade debt from suppliers. The work contributes to the existing literature by finding new empirical evidence on the substitution and matching hypotheses in times of crises, measuring the specific rationing conditions for businesses and distinguishing large, medium, small and micro-sized companies. The results revealed that, in times of crisis, medium, small and micro firms, highly likely to be constrained, employ trade credit more extensively, as those granting deferred payment terms.

Keywords:accounts payable, accounts receivable, crisis, financial rationing, trade credit

JEL Classification:

D22, G30, G32.

Institutional investor distraction and innovation

Xiaoling Pu, Hua-Hsin Tsai, M. Tony Via.

Prior studies suggest high institutional ownership provides stable funding for firm managers supporting long-term innovation. However, we hypothesize that the level of holdings can also proxy for institutional attention. We address this question and find that institutional distraction negatively impacts board monitoring and advisory support for management, reducing R&D, patent filings, citations and creativity. Distraction is concentrated in (1) firms owned by institutions providing low attention before the shock and (2) industries facing low substitute monitoring through competition. Distraction also affects information flow in firms facing high labour mobility and high peer firm innovation (technology spillovers).

Keywords:innovation, institutional ownership, investor distraction, monitoring.

JEL Classification:

G23, G30, O30.

European Financial Management, VOL 29:2, March 2023

The attack on share buybacks

Harry DeAngelo.

Corporate share buybacks are under attack, mainly from the political left, but also to some degree from the right. Critics advocate increasing the tax on buybacks in the hope of inducing firms to invest more and in ways that benefit workers. This attack on buybacks reflects a misunderstanding of basic (textbook-level) finance principles. The approach advocated by critics will backfire at growth-stage firms, which will invest less, not more, because a payout-tax increase will reduce the supply of equity infusions. At mature firms that are generating ample free cash flow, managers can easily evade the (unattractive-for-shareholders) real investments that critics desire by investing retained cash in financial assets. Buyback critics should recognise that punishing cash payouts per se would be counterproductive, and should focus instead on making a case for legislation that creates incentives that directly promote the specific behaviours they desire.

Keywords: capital infusions, corporate value creation, payout policy, share buybacks

JEL Classification:

G32, G35, G38.

SPAC merger announcement returns and subsequent performance.

Florian Kiesel, Nico Klingelhöfer, Dirk Schiereck, Silvio Vismara.

Special purpose acquisition companies (SPACs) are created to raise capital and then find non-listed operating companies with which to merge. While most of the extant research has focused on SPAC initial public offerings, we study what happens when SPACs announce business combinations. Our analysis of 236 ‘deSPACs’ completed between January 2012 and June 2021 in the United States documents an average short-term announcement return of +7.4% and a 1-year abnormal return of −14.1% (−18.0% over 2 years) for public investors beginning from the merger announcement. Short-term returns decrease with longer times from initial public offering until announcement.

Keywords: deSPACs, IPO, performance, special purpose acquisition companies (SPACs)

JEL Classification:

G14, G30, G34, G24.

Influence of endogenous reference points on the selling decisions of retail investors.

Avijit Bansal, Joshy Jacob, Ajay Pandey.

Using trader-level data, we examine the impact of the stock-specific endogenous reference points, the ‘realized-return’ and the ‘peak-return’ of the prior round on the selling propensity in a subsequent investment round in the same asset. The selling propensity rises significantly near the endogenous reference points. The significance is greater when the holding period is relatively shorter and when the time gap between the consecutive rounds is lower, implying a recency effect. Finally, the impact is more substantial on traders holding fewer stocks. The results imply that traders' prior stock-specific experience plays a significant role in the reference point formation.

Keywords: behavioural finance, investment experience, investor behaviour, reference points.

JEL Classification:

G11, G40, G41.

Interbank contagion risk in China under an ABM approach for network formation

Shiqiang Lin, Hairui Zhang.

This paper uses an agent-based model to construct an interbank network for the Chinese interbank market using a sample of 299 commercial banks from 2014 to 2019. We analyze the importance and vulnerability of banks using the DebtRank algorithm. Our results show that the Chinese interbank market bears a certain level of systemic risk, especially among lower-tiered banks. The results also show a bank is more vulnerable if it has a higher interbank lending ratio and greater financial connectivity. Meanwhile, a bank is more influential if it has a larger net worth and greater financial connectivity.

Keywords: agent‐based modelling, Chinese banking sector, contagion risk, interbank network, simulation.

JEL Classification:

C63, G17, G21

Unnatural selection of outside directors: Consequences of Japanese corporate governance reforms.

Souhei Ishida, Takuma Kochiyama.

We examine how Japanese listed companies increase the number of outside directors to comply with corporate governance reforms. We find that, after the reforms, there has been an increase in the number of cases in which former company auditors (kansayaku) become outside directors in the same company. This trend is more pronounced for hitherto noncompliant firms with insufficient outside directors before the reforms. Moreover, the firms appointing company auditors as outside directors tend to change their corporate structures to maintain existing practices and minimize compliance costs. Our findings imply that Japanese reforms have increased the unnatural selection of outside directors.

Keywords: board structure, corporate governance code, corporate governance reform, institutional theory, outside director.

JEL Classification:

G34, G38, M10.

Big data, artificial intelligence and machine learning: A transformative symbiosis in favour of financial technology.

Duc Khuong Nguyen, Georgios Sermpinis, Charalampos Stasinakis.

This paper uses a multidimensional descriptive analysis to familiarize the reader with the extent of penetration of big data, artificial intelligence (AI) and machine learning (ML) techniques in the financial technology roadmap. We propose a clear framework for the symbiotic nature of these data science themes towards fintech empowerment. The framework is validated through their impact on fintech, financial services' profession and the shifting paradigm of the data scientist role. We also discuss the dark side of this symbiosis, while AI and ML techniques are tied with the future challenges of AI ethics, regulation technology and the smart data utilization.

Keywords: artificial intelligence, big data, digital finance, fintech, machine learning.

JEL Classification:

G10, G20, L51.

US macroeconomic surprises and the emerging-market sovereign CDS market.

Junmao Chiu, Wei-Che Tsai, Chi Yin.

Our primary aim is to examine whether US macroeconomic surprises affect the slope of the term structure of ‘sovereign credit default swap’ (SCDS) spreads in emerging markets. Our empirical results show that positive (negative) US macroeconomic surprises are likely to reduce (increase) the term structure slope of SCDS spreads in emerging countries. We find that the slope values in emerging markets are positively related to future market returns over 1- and 2-day horizons. Our results provide general support for the future informational role played by SCDS spreads for the national stock market within emerging markets.

Keywords:emerging markets, sovereign credit default swaps, spillover effects.

JEL Classification:

F30, G15.

Productivity and payout policy

Manoj Kulchania.

I investigate how a firm's total factor productivity (TFP) is related to its payout policy. I find that firms with higher TFP are more likely to pay dividends and repurchase shares. Such firms also pay higher dividends and repurchase more shares, even after controlling for income and other factors known to affect payout policy. Results are robust to propensity score matching and other analyses, including adoption of productivity-enhancing technology. I find that firms with higher TFP earn higher future operating income; productive firms with higher agency concerns pay back more, thus draining resources that could potentially be misused.

Keywords: dividends, payout, productivity, repurchases.

JEL Classification:


Persistency of window dressing practices in the U.S. repo markets after the GFC: The unexplored role of the deposit insurance premium

Aziz Jaafar, Salvatore Polizzi, Alessio Reghezza

We investigate whether the regulatory improvements made in the aftermath of the global financial crisis have been effective in limiting bank downward window dressing by means of repos in the United States. We find that a strict application of the Basel III regulation wipes out incentives to engage in window dressing to bolster the level of leverage Tier 1 ratio at quarter-end. We also show that the persistency of window dressing is related to the computation of the Federal Deposit Insurance Corporation assessment base, which motivates banks to engage in window dressing to reduce the deposit insurance premium.

Keywords: bank holding companies, deposit insurance premium, leverage tier 1 ratio, repurchase agreements, window dressing.

JEL Classification:

G14, G21, G28, M41, M48.

European Financial Management, VOL 29:3, June 2023

CSR activity in response to the Paris Agreement exit.

J. Philipp Klaus, Hirofumi Nishi, S. Drew Peabody, Carolyn Reichert.

In 2017, U.S. President Donald Trump announced his intention to withdraw the United States from the Paris Agreement. Although there were concerns that the exit would impede the global effort to reduce greenhouse gas emissions, the environmental performance of U.S. firms in carbon-intensive sectors improved after the announcement at a significantly higher pace than firms in other sectors. Moreover, our findings are concentrated among firms exposed to higher public attention. One implication is that firms under greater public scrutiny used the United States' departure from the agreement as an opportunity to credibly signal their commitment to combating global climate change.

Keywords: corporate social responsibility, environment, Paris Agreement, signalling.

JEL Classification:

G14, G18, G30, M14.

The wealth effects of takeover bids regulation in the European Union.

Gilberto Loureiro, Sónia Silva.

We investigate the wealth effects of the Takeover Bids Directive, enacted by the European Union (EU), on mergers and acquisitions. The directive aims at protecting target minority shareholders by restricting antitakeovers provisions and preventing managerial entrenchment. We test the regulation impact using a treatment sample of EU public acquisitions and a control sample from outside the EU. Our results suggest diverse effects of the regulation across treatment countries: acquirers from countries with better shareholder protection engage in more value-enhancing acquisitions postregulation that could otherwise be too costly. The regulation also increases the likelihood of firms becoming targets and raises market value.

Keywords: acquisition synergies, European Union, mergers & acquisitions, M&A announcement returns, securities eegulation.

JEL Classification:

F30, G15, G30, G34, G38.

Modelling failure rates with machine-learning models: Evidence from a panel of UK firms.

Georgios Sermpinis, Serafeim Tsoukas, Yiqun Zhang.

In this study, we investigate the ability of machine-learning techniques to predict firm failures and we compare them against alternatives. Using data on business and financial risks of UK firms over 1994–2019, we document that machine-learning models are systematically more accurate than a discrete hazard benchmark. We conclude that the random forest model outperforms other models in failure prediction. In addition, we show that the improved predictive power of the random forest model relative to its counterparts persists when we consider extreme economic events as well as firm and industry heterogeneity. Finally, we find that financial factors affect failure probabilities.

Keywords: business closures, finance, financial ratios, machine‐learning models, random forest.

JEL Classification:

G17, G33, C25, E37.

Public governance and executive perks under a weak corporate governance environment.

Wei Huang, Zongyan Li, Yu Qin, Shuai Yuan.

We reveal state-led anti-corruption campaigns in China can mitigate excess executive perk consumption facilitated by firms' weak internal control environment. Our findings suggest that public governance can substitute for firm-level governance mechanisms. Since these campaigns enhance the central government's disciplinary power over local state-owned enterprises (SOEs), the above effects are heightened among SOEs controlled by provincial/municipal governments rather than the central government. Irrespective of political connections, non-SOEs are also affected, indicating policy effect spillover to China's private sectors. We explore several underlining mechanisms for these effects, including Communist Party Committee governance, chief executive officer/chairperson dismissal, industry competition, and firm productivity.

Keywords: anti‐corruption, China, internal control, perks.

JEL Classification:

G34, G38, M40.

Does social capital foster sustainable investment?

Siu Kai Choy, Iva Koci, Mingzhu Wang.

How do country-level societal norms affect financial investments? We provide evidence that mutual funds managed in high social capital countries are inclined to consider environmental, social and governance filters in their portfolios, especially when acquiring new stocks and investing abroad. We argue that social capital nurtures the investment preferences of retail investors, whose demand incentivizes fund managers to respond in kind. Such impact is more pronounced in individualistic and high–power distance societies, suggesting that the social cohesion benefit of social capital complements altruistic inclinations in the former and provides mechanisms to punish unsustainable investment behaviour in the latter.

Keywords: ESG, mutual funds, social capital, sustainable investment.

JEL Classification:

G15, G41, M14, Z13.

Are covered bonds different from securitization bonds? A comparative analysis of credit spreads.

Mafalda C. Correia, João M. Pinto.

This study compares credit spreads and pricing determinants of securitization vis-à-vis covered bonds. Our analysis reveals that although ratings are the most important pricing determinant for asset-backed securities (ABS) and mortgage-backed securities (MBS) investors place relatively more importance on contractual, macroeconomic and banks' characteristics rather than ratings in pricing covered bonds. We find evidence of a mispricing effect in structured finance markets: ABS and MBS have higher credit spreads than similarly rated public-covered bonds and mortgage-covered bonds and security prices reflect information beyond credit ratings. We find no evidence of borrowing costs affecting banks' choice between securitization and covered bonds.

Keywords: cost of borrowing, covered bonds, credit spreads, mispricing,securitization

JEL Classification:

F34, G01, G12, G24.

The term structure of mutual fund herding.

Xiaolin Huo, Xin Liu, Weinan Zheng.

This paper investigates institutional herding behaviours in the U.S. Treasury market. We find that the level of herding is higher for bonds with a longer time to maturity and this pattern is significant only for buy herding, not sell herding. This term structure of herding is stronger for funds with a shorter investment horizon. These patterns remain strong for Treasury Inflation-Protected Securities and for Treasuries with high coupon rates. Overall, our findings support investors' short-termism as a channel for the term structure of herding and are inconsistent with other herding explanations, such as spurious herding, reputational concerns and information cascades.

Keywords:herding, mutual funds, short‐termism, time to maturity,treasuries.

JEL Classification:

G11, G12, G14, G23.

Idiosyncratic risk and debt maturity dispersion.

Pyung Kun Chu, Einar C. Kjenstad.

We investigate the relation between idiosyncratic asset risk and debt maturity dispersion. Idiosyncratic asset volatility represents significant risk, which can impede the ability to obtain or maintain external debt financing necessary for business operations, and is difficult to control given its unpredictable nature. We find that this risk is managed through the maturity structure of debt: firms with higher idiosyncratic asset volatility also have more dispersed maturity structures. Consistent with active management of rollover risk, this relation is weaker for younger firms and stronger for firms without significant credit lines.

Keywords: debt maturity dispersion, idiosyncratic asset volatility,rollover risk.

JEL Classification:

G10, G32.

Twitter investor sentiment and corporate earnings announcements.

Nikolaos Karampatsas, Soheila Malekpour, Andrew Mason, Christos P. Mavis.

We examine the impact of firm-specific investor sentiment (FSIS) on stock returns for negative and positive earnings surprises. Using a measure constructed from firm-specific tweets, we find that FSIS has a greater impact on stock returns for negative relative to positive earnings surprises. We further show that the impact of FSIS is greater for firms whose valuation is uncertain and difficult to arbitrage. Moreover, we provide evidence of return reversals over post-announcement periods. Our results highlight the importance of FSIS around earnings announcements.

Keywords: earnings surprises, investor sentiment, social media, StockTwits,Twitter.

JEL Classification:

G02, G11, G12, G14.

Company name fluency and acquisition target analysis.

Ching-Yu Hsu, Chia-Wei Huang, Chih-Yen Lin.

This paper investigates the impact of company name fluency on acquisitions. We hypothesize that a company's name fluency, used by potential acquirers as a mental shortcut, influences not only its visibility to investors but also the level of interest from potential acquirers, increasing the company's acquisition probability. After correcting for endogeneity, company name fluency is positively associated with both the probability of being an acquisition target and an acquisition premium. Reasons for a higher acquisition premium for targets with higher name fluency are identified as reduced need to hire top-tier investment banks and higher synergy.

Keywords: acquisitions, company names, fluency.

JEL Classification:

G02, G34.