nep-fmk New Economics Papers
on Financial Markets
Issue of 2023‒05‒22
eight papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. FinTech Lending with LowTech Pricing By Mark J. Johnson; Itzhak Ben-David; Jason Lee; Vincent Yao
  2. Decentralized Finance (DeFi) By Mansur Bestas
  3. Deep parametric portfolio policies By Simon, Frederik; Weibels, Sebastian; Zimmermann, Tom
  4. Flip the coin: Heads, tails or cryptocurrencies? By António Manuel Portugal Duarte; Fátima Teresa Castelo Assunção Sol Murta; Nuno José Henriques Baetas da Silva; Beatriz Rodrigues Vieira
  5. Tackling the fiscal policy-financial stability nexus By Claudio Borio; Marc Farag; Fabrizio Zampolli
  6. FinTech, investor sophistication and financial portfolio choices By Leonardo Gambacorta; Romina Gambacorta; Roxana Mihet
  7. Do Banks Hedge Using Interest Rate Swaps? By Lihong McPhail; Philipp Schnabl; Bruce Tuckman
  8. Managing Portfolio Risk During the BREXIT Crisis: A Cross-Quantilogram Analysis of Stock Markets and Commodities Across European Countries, the US, and BRICS By Ayedi Ahmed; Marjène Gana; Stéphane Goutte; Khaled Guesmi

  1. By: Mark J. Johnson; Itzhak Ben-David; Jason Lee; Vincent Yao
    Abstract: FinTech lending—known for using big data and advanced technologies—promised to break away from the traditional credit scoring and pricing models. Using a comprehensive dataset of FinTech personal loans, our study shows that loan rates continue to rely heavily on conventional credit scores, including 45% higher rates for nonprime borrowers. Other known default predictors are often neglected. Within each segment (prime/nonprime) loan rates are not very responsive to default risk, resulting in realized loan-level returns decreasing with risk. The pricing distortions result in substantial transfers from nonprime to prime borrowers and from low- to high-risk borrowers within segment.
    JEL: G21 G23 G50
    Date: 2023–04
  2. By: Mansur Bestas
    Abstract: Decentralized finance, powered by blockchain technology, is growing day by day. This field, which emerged a few years ago, today manages $70 billion in assets. In this study, the concept of decentralized finance is discussed and explained the differences from traditional finance. Then, compliance with the legal regulations and the requirements to ensure compliance are mentioned. An evaluation has been made about the financial services offered by the decentralized finance field and the stock market and stablecoins that it uses as a tool while providing these services. Its economic effects, security and, privacy dimensions are examined. In the study, the differences between centralized and decentralized finance, which generally covers legal, economic, security, privacy, and market manipulation, are systematically analyzed. A structured methodology is presented to distinguish between centralized and decentralized financial services. Keywords: decentralized finance, FinTech, financial regulation, blockchain, distributed ledger technology.
    Date: 2023–02
  3. By: Simon, Frederik; Weibels, Sebastian; Zimmermann, Tom
    Abstract: We directly optimize portfolio weights as a function of firm characteristics via deep neural networks by generalizing the parametric portfolio policy framework. Our results show that network-based portfolio policies result in an increase of investor utility of between 30 and 100 percent over a comparable linear portfolio policy, depending on whether portfolio restrictions on individual stock weights, short-selling or transaction costs are imposed, and depending on an investor's utility function. We provide extensive model interpretation and show that network-based policies better capture the non-linear relationship between investor utility and firm characteristics. Improvements can be traced to both variable interactions and non-linearity in functional form. Both the linear and the network-based approach agree on the same dominant predictors, namely past return-based firm characteristics.
    Keywords: Portfolio Choice, Machine Learning, Expected Utility
    JEL: G11 G12 C58 C45
    Date: 2023
  4. By: António Manuel Portugal Duarte (University of Coimbra, Centre for Business and Economics Research, CeBER and Faculty of Economics); Fátima Teresa Castelo Assunção Sol Murta (Univ of Coimbra, CeBER, Faculty of Economics); Nuno José Henriques Baetas da Silva (Ph.D. Student at Faculty of Economics, University of Coimbra); Beatriz Rodrigues Vieira (Univ Coimbra, Faculty of Economics)
    Abstract: This paper analysis and compares the volatility of seven cryptocurrencies – Bitcoin, Dogecoin, Ethereum, BitcoinCash, Ripple, Stellar and Litecoin – to the volatility of seven centralized currencies – Yuan, Yen, Canadian Dollar, Brazilian Real, Swiss Franc, Euro and British Pound. We estimate GARCH models to analyze their volatility. The results point to a considerably high volatility of cryptocurrencies when compared to that of centralized currencies. Therefore, we conclude that cryptocurrencies still fall far short of fulfilling all the requirements to be considered as a currency, specifically regarding the functions of store of value and unit of account.
    Keywords: Centralized currencies, cryptocurrencies; GARCH models; volatility.
    Date: 2023–03
  5. By: Claudio Borio; Marc Farag; Fabrizio Zampolli
    Abstract: Tackling the fiscal policy-financial stability nexus is essential to ensure financial and hence macroeconomic stability. In this paper, we review the literature on this topic and suggest how policy could best tackle the link. Doing so involves action on two fronts. First, incorporating financial stability considerations in the design of fiscal policy. This means, in particular, considering the risk of financial crises when assessing fiscal space, recognising the flattering effects of financial booms on fiscal positions and removing or reducing fiscal incentives to private debt accumulation. Second, acknowledging that domestic currency-denominated public debt is not fully risk-free in the design of the prudential regulation of financial institutions. This calls for carefully balanced risk-sensitive capital charges or other measures to limit banks' sovereign exposures with due regard to the special role of government bonds in the financial system and country-specific characteristics. That said, prudent regulation cannot substitute for fiscal prudence.
    Keywords: financial crises; doom loops; sovereign exposures; prudential policy; fiscal policy
    JEL: E6 G2 G3 H1 H3 H6 H8
    Date: 2023–04
  6. By: Leonardo Gambacorta; Romina Gambacorta; Roxana Mihet
    Abstract: This paper analyses the links between advances in financial technology, investors' sophistication, and the composition and returns of their financial portfolios. We develop a simple portfolio choice model under asymmetric information and derive some theoretical predictions. Using detailed microdata from Banca d'Italia, we test these predictions for Italian households over the period 2004-20. In general, heterogeneity in portfolio composition and in returns between sophisticated and unsophisticated investors grows with improvements in financial technology. This heterogeneity is reduced only if financial technology is accessible to everyone and if investors have a similar capacity to use it.
    Keywords: inequality, inclusion, FinTech, innovation, Matthew Effect
    JEL: G1 G5 G4 D83 L8 O3
    Date: 2023–04
  7. By: Lihong McPhail; Philipp Schnabl; Bruce Tuckman
    Abstract: We ask whether banks use interest rate swaps to hedge the interest rate risk of their assets, primarily loans and securities. To this end, we use regulatory data on individual swap positions for the largest 250 U.S. banks. We find that the average bank has a large notional amount of swaps-- $434 billion, or more than 10 times assets. But after accounting for the significant extent to which swap positions offset each other, the average bank has essentially no net interest rate risk from swaps: a 100-basis-point increase in rates increases the value of its swaps by 0.1% of equity. There is variation across banks, with some bank swap positions decreasing and some increasing with rates, but aggregating swap positions at the level of the banking system reveals that most swap exposures are offsetting. Therefore, as a description of prevailing practice, we conclude that swap positions are not economically significant in hedging the interest rate risk of bank assets.
    JEL: G21 G32
    Date: 2023–04
  8. By: Ayedi Ahmed (UP8 - Université Paris 8 Vincennes-Saint-Denis); Marjène Gana (HEC Montréal - HEC Montréal); Stéphane Goutte (Université Paris-Saclay); Khaled Guesmi (PSB - Paris School of Business - HESAM - HESAM Université - Communauté d'universités et d'établissements Hautes écoles Sorbonne Arts et métiers université)
    Abstract: Against the backdrop of the United Kingdom's withdrawal from the European Union (BREXIT), this study examines predictability in the stock markets of sixteen European countries, the United States, and the BRICS (Brazil, China, India, Russia, and South Africa) by analyzing how their returns predict the returns of sixteen commodities at different quantile levels. The study builds upon existing literature on predictability and extends it by investigating the impact of the BREXIT crisis on these markets. The findings suggest that investors can hedge their portfolios with various commodities during times of the BREXIT crisis, but caution is advised, and the trend of both equities and commodities should be closely monitored before making investment decisions.
    Keywords: Equity markets, commodity markets, predictability, BREXIT
    Date: 2023–04–14

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