Repo markets trade off the efficient allocation of liquidity in the financial sector with resilience to funding shocks. The repo trading and clearing mechanisms are crucial determinants of the allocation-resilience tradeoff. The two common mechanisms, anonymous central-counterparty (CCP) and non-anonymous over-the-counter (OTC) markets, are inefficient and their welfare rankings depend on funding tightness. CCP (OTC) markets inefficiently liquidate high (low) quality assets for large (small) funding shocks. Two innovations to repo market design contribute to maximize welfare: a liquidity-contingent trading mechanism and a two-tiered guarantee fund.
{"title":"(In)efficient repo markets","authors":"T. Dieler, Loriano Mancini, N. Schürhoff","doi":"10.2139/ssrn.3779987","DOIUrl":"https://doi.org/10.2139/ssrn.3779987","url":null,"abstract":"Repo markets trade off the efficient allocation of liquidity in the financial sector with resilience to funding shocks. The repo trading and clearing mechanisms are crucial determinants of the allocation-resilience tradeoff. The two common mechanisms, anonymous central-counterparty (CCP) and non-anonymous over-the-counter (OTC) markets, are inefficient and their welfare rankings depend on funding tightness. CCP (OTC) markets inefficiently liquidate high (low) quality assets for large (small) funding shocks. Two innovations to repo market design contribute to maximize welfare: a liquidity-contingent trading mechanism and a two-tiered guarantee fund.","PeriodicalId":269529,"journal":{"name":"Swiss Finance Institute Research Paper Series","volume":null,"pages":null},"PeriodicalIF":0.0,"publicationDate":"2021-02-04","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"131869305","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Jéfferson A. Colombo, Fernando I. L. Cruz, L. Paese, Renan X. Cortes
Using a sample of 21 developing and developed countries, we analyze whether a well-diversified investor of traditional assets (stocks, bonds, real estate, and commodities) may benefit from investing in cryptocurrencies. Country-specific analyses indicate that cryptocurrencies usually fit in the tangent portfolio (maximum Sharpe ratio) but no -- or very little -- in the minimum variance portfolio (MVP). Out-of-sample analysis indicates that even global portfolios that already benefits from international diversification may enjoy investing marginally in cryptocurrencies: mean-variance optimal and naive with cryptocurrencies outperformed otherwise identical portfolios in terms of risk-adjusted returns. Besides, exchange rate movements do not drive this better performance -- it occurs for both local (all returns denominated in the local currency) and global perspectives (all returns in U.S. Dollars). We also find that cryptocurrencies' diversification benefits occur both before and after the COVID-19 pandemics, with the 1/N portfolio with cryptocurrencies presenting the higher risk-adjusted returns. Our paper adds to the literature by analyzing the marginal effects of adding cryptocurrencies on a sample of developing and developed economies and considering up-to-date data following the COVID-19 crisis.
{"title":"The Diversification Benefits of Cryptocurrencies in Multi-Asset Portfolios: Cross-Country Evidence","authors":"Jéfferson A. Colombo, Fernando I. L. Cruz, L. Paese, Renan X. Cortes","doi":"10.2139/ssrn.3776260","DOIUrl":"https://doi.org/10.2139/ssrn.3776260","url":null,"abstract":"Using a sample of 21 developing and developed countries, we analyze whether a well-diversified investor of traditional assets (stocks, bonds, real estate, and commodities) may benefit from investing in cryptocurrencies. Country-specific analyses indicate that cryptocurrencies usually fit in the tangent portfolio (maximum Sharpe ratio) but no -- or very little -- in the minimum variance portfolio (MVP). Out-of-sample analysis indicates that even global portfolios that already benefits from international diversification may enjoy investing marginally in cryptocurrencies: mean-variance optimal and naive with cryptocurrencies outperformed otherwise identical portfolios in terms of risk-adjusted returns. Besides, exchange rate movements do not drive this better performance -- it occurs for both local (all returns denominated in the local currency) and global perspectives (all returns in U.S. Dollars). We also find that cryptocurrencies' diversification benefits occur both before and after the COVID-19 pandemics, with the 1/N portfolio with cryptocurrencies presenting the higher risk-adjusted returns. Our paper adds to the literature by analyzing the marginal effects of adding cryptocurrencies on a sample of developing and developed economies and considering up-to-date data following the COVID-19 crisis.","PeriodicalId":269529,"journal":{"name":"Swiss Finance Institute Research Paper Series","volume":null,"pages":null},"PeriodicalIF":0.0,"publicationDate":"2021-01-23","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"125164783","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
The financial services industry is currently undergoing a major transformation, with digitization and sustainability being the core drivers. While both concepts have been researched in recent years, their intersection, often conceived as “green FinTech,” remains under-determined. Therefore, this paper contributes to this important discussion about green FinTech by, first, synthesizing the relevant literature systematically. Second, it shows the results of an empirical, in-depth analysis of the Swiss FinTech landscape both in terms of green FinTech startups as well as the services offered by the incumbents. The research results show that literature in this new domain has only emerged recently, is mostly characterized by a specific focus on isolated aspects of green FinTech and does not provide a comprehensive perspective on the topic yet. In addition, the results from the literature and the market analysis indicate that green FinTech has an impact along the whole value chain of financial services covering customer-to-customer (c2c), business-to-customer (b2c), and business-to-business (b2b) services. Today the field is predominantly captured by startup companies in contrast to the incumbents whose solutions are still rare.
{"title":"How Green FinTech Can Alleviate the Impact of Climate Change—The Case of Switzerland","authors":"Thomas Puschmann, C. Hoffmann, V. Khmarskyi","doi":"10.3390/su122410691","DOIUrl":"https://doi.org/10.3390/su122410691","url":null,"abstract":"The financial services industry is currently undergoing a major transformation, with digitization and sustainability being the core drivers. While both concepts have been researched in recent years, their intersection, often conceived as “green FinTech,” remains under-determined. Therefore, this paper contributes to this important discussion about green FinTech by, first, synthesizing the relevant literature systematically. Second, it shows the results of an empirical, in-depth analysis of the Swiss FinTech landscape both in terms of green FinTech startups as well as the services offered by the incumbents. The research results show that literature in this new domain has only emerged recently, is mostly characterized by a specific focus on isolated aspects of green FinTech and does not provide a comprehensive perspective on the topic yet. In addition, the results from the literature and the market analysis indicate that green FinTech has an impact along the whole value chain of financial services covering customer-to-customer (c2c), business-to-customer (b2c), and business-to-business (b2b) services. Today the field is predominantly captured by startup companies in contrast to the incumbents whose solutions are still rare.","PeriodicalId":269529,"journal":{"name":"Swiss Finance Institute Research Paper Series","volume":null,"pages":null},"PeriodicalIF":0.0,"publicationDate":"2020-12-21","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"123951431","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
The investigation examined some issues regarding relationship quality between buyer and seller from the perspective of an (a) financial service industry. The aim of the research investigate factors affecting relationship quality between buyer and seller in the financial service industry, and maintain a stronger and long-term relationship include client knowledge, customer orientation, expertise and similarity. The study will apply quantitative analysis which use sample instrument with the multiple regression analysis and employed the SPSS 23.0 version software. The paper has been argued customer relationship quality that will be determined by a few independent variables. Thus, it is timely to test the significance of relationship quality among buyers and sellers in the financial service industry. The research will utilize a questionnaire survey to examine customer relationship quality between buyer and seller perceptions of the influence of the various factors on relationship quality.
{"title":"The Impact of Seller-Buyer Relationship Quality in the Financial Service Industry","authors":"Xianglin Chen","doi":"10.2139/ssrn.3801320","DOIUrl":"https://doi.org/10.2139/ssrn.3801320","url":null,"abstract":"The investigation examined some issues regarding relationship quality between buyer and seller from the perspective of an (a) financial service industry. The aim of the research investigate factors affecting relationship quality between buyer and seller in the financial service industry, and maintain a stronger and long-term relationship include client knowledge, customer orientation, expertise and similarity. The study will apply quantitative analysis which use sample instrument with the multiple regression analysis and employed the SPSS 23.0 version software. The paper has been argued customer relationship quality that will be determined by a few independent variables. Thus, it is timely to test the significance of relationship quality among buyers and sellers in the financial service industry. The research will utilize a questionnaire survey to examine customer relationship quality between buyer and seller perceptions of the influence of the various factors on relationship quality.","PeriodicalId":269529,"journal":{"name":"Swiss Finance Institute Research Paper Series","volume":null,"pages":null},"PeriodicalIF":0.0,"publicationDate":"2020-12-10","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"116845522","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Adding the Voluntary Insurance, a new product in On-the-Go banking services, can be impetus meeting the 21st Century challenges. This new and increasing values are what will keep banks or firms be growing, which can facilitate economy booming in many countries such as Bangladesh. If there is no new value to offer customer, bank or firm wilts and eventually dies. Historical trends of economic growth of many countries such as Bangladesh, certainly ratify that addition of a new legal product will improve society beyond just immediate gratification of consumers. New products and services are the lifeblood of any firm or bank. Without them, firm, or bank withers on the vine and either dies or is absorbed by another firm. Banking sector is no different here where agenda-setting for having Voluntary Insurance in practice might be an important element that political actors will pursue designing policies. In this process, academicians’ contributions, besides the proposal or publications in literature might be essential.
{"title":"Voluntary Insurance for Rapid Growth of On-the-Go Banking Services in World Economy: Seeking Attentions","authors":"Dr. Akim M. Rahman Ph.D (USA)","doi":"10.2139/ssrn.3734318","DOIUrl":"https://doi.org/10.2139/ssrn.3734318","url":null,"abstract":"Adding the Voluntary Insurance, a new product in On-the-Go banking services, can be impetus meeting the 21st Century challenges. This new and increasing values are what will keep banks or firms be growing, which can facilitate economy booming in many countries such as Bangladesh. If there is no new value to offer customer, bank or firm wilts and eventually dies. Historical trends of economic growth of many countries such as Bangladesh, certainly ratify that addition of a new legal product will improve society beyond just immediate gratification of consumers. New products and services are the lifeblood of any firm or bank. Without them, firm, or bank withers on the vine and either dies or is absorbed by another firm. Banking sector is no different here where agenda-setting for having Voluntary Insurance in practice might be an important element that political actors will pursue designing policies. In this process, academicians’ contributions, besides the proposal or publications in literature might be essential.","PeriodicalId":269529,"journal":{"name":"Swiss Finance Institute Research Paper Series","volume":null,"pages":null},"PeriodicalIF":0.0,"publicationDate":"2020-11-18","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"124790939","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Investors value safety services in financial assets, such as the ability to serve as a store of value, to serve as collateral, or to meet mandatory capital and liquidity requirements. I present a model in which investors value safety services not only in traditional safe assets such as US Treasuries, but also in corporate debt. Shareholders thus maximize the value of the firm by complementing standard business operations with safe asset creation. Based on this theoretical framework, I use the CDS-bond basis to derive a measurement of the safety premium of corporate bonds. I document substantial cross sectional variation in the safety premium of corporate bonds, which allows me to test the model's predictions. I show that a high safety premium leads to a marked increase in debt issuance by relatively safer firms. These debt proceeds have a small impact on real investment and are largely used instead for equity payouts. This mechanism can explain why, in the aftermath of the financial crisis, non-financial investment grade companies significantly increased their debt issuance and equity payout while investment remained weak.
{"title":"The Corporate Supply of (Quasi) Safe Assets","authors":"L. Mota","doi":"10.2139/ssrn.3732444","DOIUrl":"https://doi.org/10.2139/ssrn.3732444","url":null,"abstract":"Investors value safety services in financial assets, such as the ability to serve as a store of value, to serve as collateral, or to meet mandatory capital and liquidity requirements. I present a model in which investors value safety services not only in traditional safe assets such as US Treasuries, but also in corporate debt. Shareholders thus maximize the value of the firm by complementing standard business operations with safe asset creation. Based on this theoretical framework, I use the CDS-bond basis to derive a measurement of the safety premium of corporate bonds. I document substantial cross sectional variation in the safety premium of corporate bonds, which allows me to test the model's predictions. I show that a high safety premium leads to a marked increase in debt issuance by relatively safer firms. These debt proceeds have a small impact on real investment and are largely used instead for equity payouts. This mechanism can explain why, in the aftermath of the financial crisis, non-financial investment grade companies significantly increased their debt issuance and equity payout while investment remained weak.","PeriodicalId":269529,"journal":{"name":"Swiss Finance Institute Research Paper Series","volume":null,"pages":null},"PeriodicalIF":0.0,"publicationDate":"2020-11-15","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"123403655","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We develop Residual MisPricing (RMP), an index capturing mispricing relative to a linear benchmark asset pricing model, from the structure imposed by no-arbitrage. RMP is fully conditional and depends only on the returns of basic assets. Return data for several economies reveal that RMP is countercyclical and related to financial uncertainty. RMP further shows a strong positive relation to conditional international equity and currency risk premia, as well as a close link to market-wide funding liquidity shocks. The relations we document hold in particular out-of-sample. Our evidence points to new record highs for RMP during the COVID-19 era, similar to its behavior in the 2008 financial crisis.
{"title":"Mispricing and Uncertainty in International Markets","authors":"Mirela Sandulescu, P. Schneider","doi":"10.2139/ssrn.3785528","DOIUrl":"https://doi.org/10.2139/ssrn.3785528","url":null,"abstract":"We develop Residual MisPricing (RMP), an index capturing mispricing relative to a linear benchmark asset pricing model, from the structure imposed by no-arbitrage. RMP is fully conditional and depends only on the returns of basic assets. Return data for several economies reveal that RMP is countercyclical and related to financial uncertainty. RMP further shows a strong positive relation to conditional international equity and currency risk premia, as well as a close link to market-wide funding liquidity shocks. The relations we document hold in particular out-of-sample. Our evidence points to new record highs for RMP during the COVID-19 era, similar to its behavior in the 2008 financial crisis.","PeriodicalId":269529,"journal":{"name":"Swiss Finance Institute Research Paper Series","volume":null,"pages":null},"PeriodicalIF":0.0,"publicationDate":"2020-11-02","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"121467605","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
I propose a new measure of investor disagreement based on thirty-nine factors from the return-predicting anomaly literature. Consistent with theoretical work on volume, I show that a one standard deviation change in anomaly-based disagreement is associated with a 16.7% higher turnover in the next period. The positive and significant relationship is robust to different specifications, alternative measures of turnover and disagreement, and different periods. I document that a firm's information environment moderates the effect of disagreement on volume. Disagreement effects are stronger for firms with less public information and more complex information releases. Anomaly-based disagreement also explains analyst behavior - it is positively related to their forecast dispersion and absolute forecast errors in earnings and target prices.
{"title":"Trading Volume and Dispersion of Signals","authors":"Nikhil Vidhani","doi":"10.2139/ssrn.3682088","DOIUrl":"https://doi.org/10.2139/ssrn.3682088","url":null,"abstract":"I propose a new measure of investor disagreement based on thirty-nine factors from the return-predicting anomaly literature. Consistent with theoretical work on volume, I show that a one standard deviation change in anomaly-based disagreement is associated with a 16.7% higher turnover in the next period. The positive and significant relationship is robust to different specifications, alternative measures of turnover and disagreement, and different periods. I document that a firm's information environment moderates the effect of disagreement on volume. Disagreement effects are stronger for firms with less public information and more complex information releases. Anomaly-based disagreement also explains analyst behavior - it is positively related to their forecast dispersion and absolute forecast errors in earnings and target prices.","PeriodicalId":269529,"journal":{"name":"Swiss Finance Institute Research Paper Series","volume":null,"pages":null},"PeriodicalIF":0.0,"publicationDate":"2020-10-13","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"126619041","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
A. Zahariev, Stoyan Prodanov, A. Radulova, G. Zaharieva, M. Pavlova, P. Angelov, T. Ismailov, A. Aleksandrova, Kristi Marinova
A study of the international experience of applicable policies for crisis management in the credit system in bank insolvency, identifies three types of solutions, including: elimination of the "toxic element" in the banking system following the example of "Lehman Brothers" in the US from 15 09 2008 through a voluntary insolvency procedure declared by the bank's management before the respective regulatory body;support for the financially troubled institution through nationalization and a reform plan following the example of Northern Rock in the UK from 2007-2008 and Greek banks from the Greek debt crisis after 2010;liquidation of the "toxic element" in the banking system, following the example of CCB in Bulgaria (2014-2020), through a regulatory insolvency procedure Each of the three policies has its pros and cons, but it definitely has a "stressful" impact on banking systems and economic agents with long-term consequences, incl in the context of the TBTF doctrine On this basis, international regulators are introducing the methodology of bank stress tests for early warning of bank insolvency The study of the experience of the central banks, BIS and ECB for conducting stress tests brings to the fore their grouping by three criteria: first criteria - Type of stress test, which distinguishes stress tests conducted by macroprudential authorities for the purpose of assessing broad systemic risks, stress tests conducted by microprudential authorities for supervisory purposes and stress tests by the internal bank risk management for the purposes of assessing capital adequacy policies;second criteria - Focus of the stress test, which distinguishes systematic assessments at the institutional level, measuring mainly solvency or liquidity, assessments on the first and second pillars of Basel II, as well as assessments of financial instruments, investment portfolios, business sectors from institutional positions to prepare models for decision-making by the central banking management regarding the response to the various risks;and third criteria - Approach to conducting the stress test, which is grouped into two categories, top - down and vice versa, bottom - up These approaches must be tested with the new environment for COVID-19 as a global systemic risk generator Its impact on the creditworthiness of companies, households and the state can be assessed as extremely negative and testing the capital adequacy of commercial banks under BASEL III framework
{"title":"The Bank Insolvency: From Lehman Brothers to COVID-19 (International Remarks and National Peculiarities)","authors":"A. Zahariev, Stoyan Prodanov, A. Radulova, G. Zaharieva, M. Pavlova, P. Angelov, T. Ismailov, A. Aleksandrova, Kristi Marinova","doi":"10.2139/ssrn.3688961","DOIUrl":"https://doi.org/10.2139/ssrn.3688961","url":null,"abstract":"A study of the international experience of applicable policies for crisis management in the credit system in bank insolvency, identifies three types of solutions, including: elimination of the \"toxic element\" in the banking system following the example of \"Lehman Brothers\" in the US from 15 09 2008 through a voluntary insolvency procedure declared by the bank's management before the respective regulatory body;support for the financially troubled institution through nationalization and a reform plan following the example of Northern Rock in the UK from 2007-2008 and Greek banks from the Greek debt crisis after 2010;liquidation of the \"toxic element\" in the banking system, following the example of CCB in Bulgaria (2014-2020), through a regulatory insolvency procedure Each of the three policies has its pros and cons, but it definitely has a \"stressful\" impact on banking systems and economic agents with long-term consequences, incl in the context of the TBTF doctrine On this basis, international regulators are introducing the methodology of bank stress tests for early warning of bank insolvency The study of the experience of the central banks, BIS and ECB for conducting stress tests brings to the fore their grouping by three criteria: first criteria - Type of stress test, which distinguishes stress tests conducted by macroprudential authorities for the purpose of assessing broad systemic risks, stress tests conducted by microprudential authorities for supervisory purposes and stress tests by the internal bank risk management for the purposes of assessing capital adequacy policies;second criteria - Focus of the stress test, which distinguishes systematic assessments at the institutional level, measuring mainly solvency or liquidity, assessments on the first and second pillars of Basel II, as well as assessments of financial instruments, investment portfolios, business sectors from institutional positions to prepare models for decision-making by the central banking management regarding the response to the various risks;and third criteria - Approach to conducting the stress test, which is grouped into two categories, top - down and vice versa, bottom - up These approaches must be tested with the new environment for COVID-19 as a global systemic risk generator Its impact on the creditworthiness of companies, households and the state can be assessed as extremely negative and testing the capital adequacy of commercial banks under BASEL III framework","PeriodicalId":269529,"journal":{"name":"Swiss Finance Institute Research Paper Series","volume":null,"pages":null},"PeriodicalIF":0.0,"publicationDate":"2020-09-08","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"128514869","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Using an agent-based model (ABM) with fundamentalists and chartists, prone to develop bubbles and crashes, we demonstrate the usefulness of direct market intervention by a policy maker, documenting strong performance in preventing bubbles and drawdowns and augmenting significantly the welfare of all investors. In our ABM, the policy maker diagnoses burgeoning bubbles by forming an expectation of the future return of the risky asset in the form of an exponential moving average of the excess return over the long-term return. The policy maker invests in the risky asset when he detects a small deviation of the return from the long-term growth rate in order to construct an inventory that he draws upon later to fight future market exuberance. Then, when this deviation between the current growth rate and the long-term growth rate exceeds the policy maker's tolerance level, he starts to sell the risky asset that he has accumulated earlier, in a countercyclical fight against future price increase. We find that the policy maker succeeds in preventing bubbles and crashes in our ABM. In simulations without bubbles, the policy maker behaves similarly to the fundamentalists and his impact is negligible, following the principle of "Primum non nocere". In simulations where bubbles form spontaneously as a result of the noise traders's strategies, the policy maker's intervention reduces the average drawdown by a factor of two when his market impact becomes significant. We find that the policy maker intervention improves all analysed metrics of market returns, including volatility, skewness, kurtosis and VaR, making the market less turbulent and more stable. The combination of fewer bubbles and crashes, lower market risks and the stability of the long-term growth rate make the policy maker intervention to improve the welfare of all investors as measured by their risk-adjusted return, increasing the Sharpe ratios from approximately 0.3 to 0.5 for noise traders, from 0.6 to 0.8 for fundamentalists as the market impact of the policy maker increases to the level of the fundamentalists. We also test the sensitivity of these results to variations of the key parameters of the strategy of the policy maker and find very robust outcomes. In particular, the conclusions are unchanged even under very large miscalibrated long-term expected returns of the risky asset.
{"title":"How Market Intervention Can Prevent Bubbles and Crashes","authors":"Rebecca Westphal, D. Sornette","doi":"10.2139/ssrn.3683858","DOIUrl":"https://doi.org/10.2139/ssrn.3683858","url":null,"abstract":"Using an agent-based model (ABM) with fundamentalists and chartists, prone to develop bubbles and crashes, we demonstrate the usefulness of direct market intervention by a policy maker, documenting strong performance in preventing bubbles and drawdowns and augmenting significantly the welfare of all investors. In our ABM, the policy maker diagnoses burgeoning bubbles by forming an expectation of the future return of the risky asset in the form of an exponential moving average of the excess return over the long-term return. The policy maker invests in the risky asset when he detects a small deviation of the return from the long-term growth rate in order to construct an inventory that he draws upon later to fight future market exuberance. Then, when this deviation between the current growth rate and the long-term growth rate exceeds the policy maker's tolerance level, he starts to sell the risky asset that he has accumulated earlier, in a countercyclical fight against future price increase. We find that the policy maker succeeds in preventing bubbles and crashes in our ABM. In simulations without bubbles, the policy maker behaves similarly to the fundamentalists and his impact is negligible, following the principle of \"Primum non nocere\". In simulations where bubbles form spontaneously as a result of the noise traders's strategies, the policy maker's intervention reduces the average drawdown by a factor of two when his market impact becomes significant. We find that the policy maker intervention improves all analysed metrics of market returns, including volatility, skewness, kurtosis and VaR, making the market less turbulent and more stable. The combination of fewer bubbles and crashes, lower market risks and the stability of the long-term growth rate make the policy maker intervention to improve the welfare of all investors as measured by their risk-adjusted return, increasing the Sharpe ratios from approximately 0.3 to 0.5 for noise traders, from 0.6 to 0.8 for fundamentalists as the market impact of the policy maker increases to the level of the fundamentalists. We also test the sensitivity of these results to variations of the key parameters of the strategy of the policy maker and find very robust outcomes. In particular, the conclusions are unchanged even under very large miscalibrated long-term expected returns of the risky asset.","PeriodicalId":269529,"journal":{"name":"Swiss Finance Institute Research Paper Series","volume":null,"pages":null},"PeriodicalIF":0.0,"publicationDate":"2020-08-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"130283544","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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