nep-fmk New Economics Papers
on Financial Markets
Issue of 2023‒03‒13
fifteen papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Gambling for recovery? Exploring the riskiness of European insurers' assets during the Covid-19 crisis 2020 By Beyer, Marcel
  2. Characterizing Financial Market Coverage using Artificial Intelligence By Jean Marie Tshimula; D'Jeff K. Nkashama; Patrick Owusu; Marc Frappier; Pierre-Martin Tardif; Froduald Kabanza; Armelle Brun; Jean-Marc Patenaude; Shengrui Wang; Belkacem Chikhaoui
  3. Adaptive hedging horizon and hedging performance estimation By Wang Haoyu; Junpeng Di; Qing Han
  4. On the Fragility of DeFi Lending By Jonathan Chiu; Emre Ozdenoren; Kathy Yuan; Shengxing Zhang
  5. Short Squeeze in DeFi Lending Market: Decentralization in Jeopardy? By Lioba Heimbach; Eric G. Schertenleib; Roger Wattenhofer
  6. Cryptocurrency competition: An empirical test of Hayek's vision of private monies By Mayer, Fabian; Bofinger, Peter
  7. Constrained liquidity provision in currency markets By Wenqian Huang; Angelo Ranaldo; Andreas Schrimpf; Fabricius Somogyi
  8. Decentralized Exchanges: The Profitability Frontier of Constant Product Market Makers By Tobias Bitterli; Fabian Sch\"ar
  9. Performance attribution with respect to interest rates, FX, carry, and residual market risks By Jan-Frederik Mai
  10. The Rule of Law in the ESG Framework in the World Economy By LEOGRANDE, ANGELO
  11. Order book regulatory impact on stock market quality: a multi-agent reinforcement learning perspective By Johann Lussange; Boris Gutkin
  12. Understanding the “Inconvenience” of U.S. Treasury Bonds By Wenxin Du; Benjamin Hébert; Wenhao Li
  13. Macroeconomic Factors and UK Stock Market: Evidence through the Non-Linear ARDL model By NEIFAR, MALIKA
  14. The Benefit of Inflation-Indexed Debt: Evidence from an Emerging Bond Market By Cristhian Hernando Ruiz Cardozo; Jens H. E. Christensen
  15. Household portfolios and financial literacy: The flight to delegation By Sarah Brown; Alexandros Kontonikas; Alberto Montagnoli; Harry Pickard; Karl Taylor

  1. By: Beyer, Marcel
    Abstract: In crisis times, insurance companies might feel the pressure to present a performance of their investment portfolios that is superior to the market, since investment portfolios back the claims of policyholders and serve as a signal for the claims' safety. I seek to show whether a stock market crisis as experienced over the course of the Covid-19 pandemic influences insurance firms' decisions on the allocation of credit risk bearing assets in their investment portfolio. I find, consistently with previous research, that insurers shift their portfolio holdings towards lower credit risk assets as financial market conditions tighten. This tendency seems to be restricted by the liquidity risk of high-yield assets, and the credit risk of lower-rated investment-grade assets. Both effects ultimately lead to a larger fraction of less liquid assets during the crisis and the recovery.
    Keywords: Insurance, Covid-19, Financial Stability
    JEL: G01 G11 G22 G32
    Date: 2023
  2. By: Jean Marie Tshimula; D'Jeff K. Nkashama; Patrick Owusu; Marc Frappier; Pierre-Martin Tardif; Froduald Kabanza; Armelle Brun; Jean-Marc Patenaude; Shengrui Wang; Belkacem Chikhaoui
    Abstract: This paper scrutinizes a database of over 4900 YouTube videos to characterize financial market coverage. Financial market coverage generates a large number of videos. Therefore, watching these videos to derive actionable insights could be challenging and complex. In this paper, we leverage Whisper, a speech-to-text model from OpenAI, to generate a text corpus of market coverage videos from Bloomberg and Yahoo Finance. We employ natural language processing to extract insights regarding language use from the market coverage. Moreover, we examine the prominent presence of trending topics and their evolution over time, and the impacts that some individuals and organizations have on the financial market. Our characterization highlights the dynamics of the financial market coverage and provides valuable insights reflecting broad discussions regarding recent financial events and the world economy.
    Date: 2023–02
  3. By: Wang Haoyu; Junpeng Di; Qing Han
    Abstract: In this study, we constitute an adaptive hedging method based on empirical mode decomposition (EMD) method to extract the adaptive hedging horizon and build a time series cross-validation method for robust hedging performance estimation. Basing on the variance reduction criterion and the value-at-risk (VaR) criterion, we find that the estimation of in-sample hedging performance is inconsistent with that of the out-sample hedging performance. The EMD hedging method family exhibits superior performance on the VaR criterion compared with the minimum variance hedging method. The matching degree of the spot and futures contracts at the specific time scale is the key determinant of the hedging performance in the corresponding hedging horizon.
    Date: 2023–02
  4. By: Jonathan Chiu; Emre Ozdenoren; Kathy Yuan; Shengxing Zhang
    Abstract: We develop a dynamic model of decentralized finance (DeFi) lending that incorporates two/these key features: 1) borrowing and lending are decentralized, anonymous, overcollateralized and backed by the market value of crypto assets where contract terms are pre-specified and rigid; and 2) information friction exists between borrowers and lenders. We identify a price-liquidity feedback: the market outcome in any given period depends on agents’ expectations about lending activities in future periods, with higher price expectations leading to more lending and higher prices in that period. Given the rigidity inherent to smart contracts, this feedback leads to multiple self-fulfilling equilibria where DeFi lending and asset prices move with market sentiment. We show that flexible updates of smart contracts can restore equilibrium uniqueness. This finding highlights the difficulty of achieving stability and efficiency in a decentralized environment without a liquidity backstop.
    Keywords: Digital currencies and fintech; Financial stability
    JEL: G10 G01
    Date: 2023–02
  5. By: Lioba Heimbach; Eric G. Schertenleib; Roger Wattenhofer
    Abstract: Anxiety levels in the AAVE community spiked in November 2022 as Avi Eisenberg performed an attack on AAVE. Eisenberg attempted to short the CRV token by using funds borrowed on the protocol to artificially deflate the value of CRV. While the attack was ultimately unsuccessful, it left the AAVE community scared and even raised question marks regarding the feasibility of large lending platforms under decentralized governance. In this work, we analyze Avi Eisenberg's actions and show how he was able to artificially lower the price of CRV by selling large quantities of borrowed CRV for stablecoins on both decentralized and centralized exchanges. Despite the failure of his attack, it still led to approximately 1.6 Mio USD of irretrievable debt and, thereby, quadrupled the protocol's irretrievable debt. Furthermore, we highlight that his attack was enabled by the vast proportion of CRV available to borrow as well as AAVE's lending protocol design hindering rapid intervention. We stress Eisenberg's attack exposes a predicament of large DeFi lending protocols: limit the scope or compromise on `decentralization'.
    Date: 2023–02
  6. By: Mayer, Fabian; Bofinger, Peter
    Abstract: We investigate monopolistic tendencies and the intensity of currency competition on the crypto market in the light of Hayek's "Denationalization of money". Interestingly, Hayek never considered differentiation and specialization by innovative private currencies could lead lasting currency competition instead of network effects. We argue that competition between private currencies could run on different functions of money, especially the function as a store of value and that as a means of exchange, which partly explains the differences in the set-up of private currencies that Hayek demanded and that of cryptocurrencies. Drawing on a large sample of 101 cryptocurrencies and a time frame from 2016 to 2022, we empirically examine the evolution and degree of competition on the crypto market, also taking changes in general crypto market structure into account. We find that competition is strong for unpegged cryptocurrencies that mostly compete as a speculative store of value. Competition is also strong for stablecoins when competing as a stable store of value. Competition is much less pronounced for the function as a means of exchange and network effects and monopolistic tendencies are more likely to be present on this sub-market.
    Keywords: Hayek, Cryptocurrencies, Functions of Money, Currency Competition, NetworkEffects, Monopol
    JEL: B25 D40 E42 E50 E51 L11
    Date: 2023
  7. By: Wenqian Huang; Angelo Ranaldo; Andreas Schrimpf; Fabricius Somogyi
    Abstract: We study dealers’ liquidity provision in the currency market. We show that at times when dealers’ intermediation capacity is constrained their cost of liquidity provision increases disproportionately relative to dealer-provided volume. As a result, the elasticity of dealers’ liquidity provision drops by at least 80% relative to periods when they are unconstrained. We identify constrained periods based on leverage ratios, Value-at-Risk measures, credit default spreads, and debt funding costs. We interpret our novel empirical findings within a parsimonious model that sheds light on the key mechanisms of how liquidity provision by dealers tends to weaken when intermediary constraints are tightening.
    Keywords: currency markets, dealer constraints, market liquidity, foreign exchange, liquidity provision
    JEL: F31 G12 G15
    Date: 2023–02
  8. By: Tobias Bitterli; Fabian Sch\"ar
    Abstract: In this paper we analyze constant product market makers (CPMMs). We formalize the liquidity providers' profitability conditions and introduce a concept we call the profitability frontier in the xyk-space. We study the effect of mint and burn fees on the profitability frontier, consider various pool types, and compile a large data set from all Uniswap V2 transactions. We use this data to further study our theoretical framework and the profitability conditions. We show how the profitability of liquidity provision is severely affected by the costs of mint and burn events relative to the portfolio size and the characteristics of the trading pair.
    Date: 2023–02
  9. By: Jan-Frederik Mai
    Abstract: We develop a method to decompose the PnL of a portfolio of assets into four parts: (a) PnL due to FX rate changes, (b) PnL due to interest rate changes, (c) carry gain due to time passing, (d) PnL due to residual market risk changes (credit risk, liquidity risk, volatility risk etc.). We demonstrate the usefulness of our approach by decomposing the performance of an FX- and interest rate-hedged negative basis position in our fund XAIA Credit Basis II, and we apply the methodology to decompose the performance of our fund XAIA Credit Debt Capital in the first quarter of 2022 into PnL contributions of the single positions.
    Date: 2023–02
    Abstract: In this article, I have estimated the Rule of Law for 193 countries using data from the Environment Social and Governance-ESG database of World Bank. I have used different econometric techniques to estimate the value of “Rule of Law” i.e.: Panel Data with Fixed Effects, Panel Data with Random Effects, Pooled OLS. I found that Rule of Law is positively associated, among others to “Regulatory Quality” and “Control of Corruption” and negatively associated among others to, “Access to Electricity” and “Prevalence of Overweight”. I have performed a cluster analysis with the k-Mean algorithm optimized with the Elbow Method and I find the presence of four clusters. Finally, I present a confrontation among eight different machine-learning algorithms to predict the level of Rule of Law. I find that Linear Regression is the best predictor according to MAE, MSE, RMSE and R-squared.
    Keywords: Analysis of Collective Decision-Making, General, Political Processes: Rent-Seeking, Lobbying, Elections, Legislatures, and Voting Behaviour, Bureaucracy, Administrative Processes in Public Organizations, Corruption, Positive Analysis of Policy Formulation, and Implementation.
    JEL: D7 D70 D71 D72 D73 D78
    Date: 2023–02–11
  11. By: Johann Lussange; Boris Gutkin
    Abstract: Recent technological developments have changed the fundamental ways stock markets function, bringing regulatory instances to assess the benefits of these developments. In parallel, the ongoing machine learning revolution and its multiple applications to trading can now be used to design a next generation of financial models, and thereby explore the systemic complexity of financial stock markets in new ways. We here follow on a previous groundwork, where we designed and calibrated a novel agent-based model stock market simulator, where each agent autonomously learns to trade by reinforcement learning. In this Paper, we now study the predictions of this model from a regulator's perspective. In particular, we focus on how the market quality is impacted by smaller order book tick sizes, increasingly larger metaorders, and higher trading frequencies, respectively. Under our model assumptions, we find that the market quality benefits from the latter, but not from the other two trends.
    Date: 2023–02
  12. By: Wenxin Du; Benjamin Hébert; Wenhao Li
    Abstract: The U.S. Treasury market is one of the most liquid financial markets in the world, and Treasury bonds have long been considered a safe haven for global investors. It is often believed that Treasury bonds earn a “convenience yield, ” in the sense that investors are willing to accept a lower yield on them compared to other investments with the same cash flows owing to Treasury bonds’ safety and liquidity. However, since the global financial crisis (GFC), long-maturity U.S. Treasury bonds have traded at a yield consistently above the interest rate swap rate of the same maturity. The emergence of the “negative swap spread” appears to suggest that Treasury bonds are “inconvenient, ” at least relative to interest rate swaps. This post dives into this Treasury “inconvenience” premium and highlights the role of dealers’ balance sheet constraints in explaining it.
    Keywords: Treasury Market; Covered interest rate parity; interest rate swaps
    JEL: G1 G2
    Date: 2023–02–06
    Abstract: In this study, we examined the impact of some relevant UK macroeconomic factors, such as consumer price, interest rate, and exchange rates on UK stock price fluctuation by using the monthly data from 2008m01 to 2018m04. A general form of asymmetric Non-linear Auto-Regressive Distributed Lag (NARDL) model is adopted to examine the Generalized Fisher hypothesis (GFH). The Fpss bound test of (Pesaran, Shin, & Smith, 2001) for no co-integration shows the evidence of co-integration between the underlying variables. The estimated NARDL model provides strong evidence of stable long-run relationship between stock prices and deflation while the relation with inflation is not present. Both interest rate and exchange rate as independent regressors show negative significant long-run relationships with the stock market price. However, it is only the interest rate which has a significant effect for the stock price short-run adjustment to the new long-run stable equilibrium.
    Keywords: UK Stock Market, Macroeconomic Factors, Generalized Fisher hypothesis (GFH), NARDL model.
    JEL: C22 G14 G15
    Date: 2023–02–12
  14. By: Cristhian Hernando Ruiz Cardozo; Jens H. E. Christensen
    Abstract: Portfolio diversification is as important to debt management as it is to asset management. In this paper, we focus on diversification of sovereign debt issuance through greater reliance on inflation-indexed bonds for a representative emerging economy, Colombia. Using an arbitrage-free dynamic term structure model of fixed-coupon and inflation-indexed bond prices, we account for inflation and liquidity risk premia and calculate the net benefit of issuing inflation-indexed bonds over nominal bonds. Our results suggest that the Colombian government could lower its funding costs by as much as 0.69 percent by increasing its issuance of inflation-indexed debt, in particular at long maturities.
    Keywords: term structures; Modeling; liquidity risk; financial market frictions; central bank credibility; debt management
    JEL: D84 E31 E43 E44 E47 E52 E58 G12
    Date: 2023–02–02
  15. By: Sarah Brown (Department of Economics, University of Sheffield, UK; and IZA Bonn); Alexandros Kontonikas (Essex Business School, University of Essex); Alberto Montagnoli (Department of Economics, University of Sheffield, UK); Harry Pickard (Newcastle University Business School, Newcastle University); Karl Taylor (Department of Economics, University of Sheffield; and IZA Bonn)
    Abstract: In this paper we analyse the asset allocation of European households, focusing on developments during the period that followed the recent twin financial crises. We examine whether “search for yield” materialises outside financial institutions and whether the degree of financial literacy plays a role. We consider a wider set of alternatives to the safe assets by incorporating mutual funds to the standard set of stocks and bonds. We provide novel evidence which suggests that the “search for yield” during the post-crisis period of low interest rates took place not by raising the direct holdings of stocks and bonds, but rather indirectly through higher mutual funds’ holdings, in line with a “flight to delegation”. Importantly, this behaviour is strongly linked to the level of financial literacy, with the most literate households displaying significantly higher use of mutual funds.
    Keywords: Asset allocation; Financial literacy; Delegation
    JEL: E2 E44 G11 G51
    Date: 2023–02

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