The non-linear market impact of large trades: evidence from buy-side order flow

We perform an empirical study of a set of large institutional orders executed in the US equity market. Our results validate the hidden order arbitrage theory proposed by Farmer et al. [How efficiency shapes market impact, 2013] of the market impact of large institutional orders. We find that large trades are drawn from a distribution with tail exponent of roughly 3/2 and that market impact approximately increases as the square root of trade duration. We examine price reversion after the completion of a trade, finding that permanent impact is also a square root function of trade duration and that its ratio to the total impact observed at the last fill is roughly 2/3. Additionally, we confirm empirically that the post-trade price reverts to a level consistent with a fair pricing condition of Farmer et al. (2013 Farmer, D., Gerig, A., Lillo, F. and Waelbroeck, H., How efficiency shapes market impact, 2013. Available online at: http://arxiv.org/abs/1102.5457 [Google Scholar]). We study the relaxation dynamics of market impact and find that impact decay is a multi-regime process, approximated by a power law in the first few minutes after order completion and subsequently by exponential decay.     

Erratum to: Utility maximization in incomplete markets with random endowment

K. Larsen, M. Soner and G. ?itkovi? kindly pointed out to us an error in our paper (Cvitani? et al. in Finance Stoch. 5:259–272, 2001) which appeared in 2001 in this journal. They also provide an explicit counterexample in Larsen et al. (https://arxiv.org/abs/1702.02087, 2017).In Theorem 3.1 of Cvitani? et al. (Finance Stoch. 5:259–272, 2001), it was incorrectly claimed (among several other correct assertions) that the value function \(u(x)\) is continuously differentiable. The erroneous argument for this assertion is contained in Remark 4.2 of Cvitani? et al. (Finance Stoch. 5:259–272, 2001), where it was claimed that the dual value function \(v(y)\) is strictly concave. As the functions \(u\) and \(v\) are mutually conjugate, the continuous differentiability of \(u\) is equivalent to the strict convexity of \(v\). By the same token, in Remark 4.3 of Cvitani? et al. (Finance Stoch. 5:259–272, 2001), the assertion on the uniqueness of the element \(\hat{y}\) in the supergradient of \(u(x)\) is also incorrect.Similarly, the assertion in Theorem 3.1(ii) that \(\hat{y}\) and \(x\) are related via \(\hat{y}=u'(x)\) is incorrect. It should be replaced by the relation \(x=-v'(\hat{y})\) or, equivalently, by requiring that \(\hat{y}\) is in the supergradient of \(u(x)\).To the best of our knowledge, all the other statements in Cvitani? et al. (Finance Stoch. 5:259–272, 2001) are correct.As we believe that the counterexample in Larsen et al. (https://arxiv.org/abs/1702.02087, 2017) is beautiful and instructive in its own right, we take the opportunity to present it in some detail.     

How do Professional Financial Services Firms Understand their Skill Needs and Organise their Recruitment Practices?

Abstract

The recruitment practices of professional financial service firms are informed by hegemonic cultural norms embedded in global and national institutions. There is a propensity, particularly in the financial services, to employ ‘people like us’ [Erel, U. (2010). Migrating cultural capital: Bourdieu in migration studies. Sociology, 44(4), 642–660. doi:10.1177/0038038510369363], which, it is argued, has constrained the employment outcomes of skilled migrants. Using the concept of cultural fit, this paper draws on interviews with representatives of accounting firms in Australia to understand the criteria for recruiting in a highly commercialised and globalised professional labour market. The results demonstrate that client-focused firms place an emphasis on cultural fit in the recruitment process. It is concluded that a lack of cultural capital by migrants means that their efforts to infiltrate the professional accounting labour market in Australia are limited. Furthermore, from an education perspective, the skill set taught in the accounting curriculum is increasingly geared to meet the recruitment strategies of professional service firms.     

Accounting Community of Practice pedagogy: a course management invention for developing personal competencies in accounting education

This paper reports the findings of an exploratory qualitative study using the implementation of Wenger’s [(1998). Communities of practice: Learning, meaning, and identity. Cambridge, MA: Cambridge University Press; Wenger, E. (2000). Communities of practice and social learning systems. Organization, 7(2), 225–246] Theory of Communities of Practice to develop an Accounting Community of Practice (ACOP) pedagogy. Students from eight accounting courses who participated, in the120 narratives and 280 surveys used as data, practice and develop critical real-world professional accounting competencies by linking three structural foundations: (1) accountability to joint enterprise, (2) mutual engagement, and (3) shared repertoire of communal resources. Competencies promoted by the AICPA [(1999). Core competency framework of entry into the accounting profession. Retrieved from http://www.aicpa.org/edu/corecomp.htm; AICPA. (2006). Core competency framework of entry into the accounting profession. Retrieved from http://www.aicpa.org/edu/corecomp.htm); International Federation of Accountants (IFAC). (2003). International education standard No. 3, professional skills. Retrieved from www.ifac.org; IFAC. (2015). Meeting future expectations of professional competence: A consultation on the IAESB’S future strategies and priorities. Retrieved from www.iaesb.org; ICAEW. (1996). Added value professionals: Chartered accountants in England and Wales. London: Author], and other professional bodies include problem-solving, leadership, project management, and interaction. ACOP strategy is effective in maintaining dynamic learning environments, increasing students’ awareness of trust, open communication, and creative thinking. Meaning and knowledge are owned in ACOP where the focus of the class shifts from instructor to students. This study adds to limited empirical research in communal forms of learning in accounting.     

Predictive Modeling in Long-Term Care Insurance

The accurate prediction of long-term care insurance (LTCI) mortality, lapse, and claim rates is essential when making informed pricing and risk management decisions. Unfortunately, academic literature on the subject is sparse and industry practice is limited by software and time constraints. In this article, we review current LTCI industry modeling methodology, which is typically Poisson regression with covariate banding/modification and stepwise variable selection. We test the claim that covariate banding improves predictive accuracy, examine the potential downfalls of stepwise selection, and contend that the assumptions required for Poisson regression are not appropriate for LTCI data. We propose several alternative models specifically tailored toward count responses with an excess of zeros and overdispersion. Using data from a large LTCI provider, we evaluate the predictive capacity of random forests and generalized linear and additive models with zero-inflated Poisson, negative binomial, and Tweedie errors. These alternatives are compared to previously developed Poisson regression models.

Our study confirms that variable modification is unnecessary at best and automatic stepwise model selection is dangerous. After demonstrating severe overprediction of LTCI mortality and lapse rates under the Poisson assumption, we show that a Tweedie GLM enables much more accurate predictions. Our Tweedie regression models improve average predictive accuracy (measured by several prediction error statistics) over Poisson regression models by as much as four times for mortality rates and 17 times for lapse rates.     

Pricing European-type,early-exercise and discrete barrier options using an algorithm for the convolution of Legendre series

This paper applies an algorithm for the convolution of compactly supported Legendre series (the CONLeg method) (cf. Hale and Townsend, An algorithm for the convolution of Legendre series. SIAM J. Sci. Comput., 2014, 36, A1207–A1220), to pricing European-type, early-exercise and discrete-monitored barrier options under a Lévy process. The paper employs Chebfun (cf. Trefethen et al., Chebfun Guide, 2014 (Pafnuty Publications: Oxford), Available online at: http://www.chebfun.org/) in computational finance and provides a quadrature-free approach by applying the Chebyshev series in financial modelling. A significant advantage of using the CONLeg method is to formulate option pricing and option Greek curves rather than individual prices/values. Moreover, the CONLeg method can yield high accuracy in option pricing when the risk-free smooth probability density function (PDF) is smooth/non-smooth. Finally, we show that our method can accurately price options deep in/out of the money and with very long/short maturities. Compared with existing techniques, the CONLeg method performs either favourably or comparably in numerical experiments.     

The Impact of IFRS 16 on Key Financial Ratios: A New Methodological Approach

In January 2016, the International Accounting Standards Board issued a new standard for lease accounting: International Financial Reporting Starndard (IFRS) 16. IFRS 16 will lead to the capitalisation of the majority of current operating leases by lessees. We analyse the impact of the new accounting model on entity’s key financial, contributing to research by making significant changes in the Imhoff et al. [(1991). Operating leases: Impact of constructive capitalization. Accounting Horizons, 5(1), 51–63. Retrieved from http://search.ebscohost.com/login.aspx?direct=true&;db=buh&;AN=9604010111&;site=ehost-live; (1997). Operating leases: Income effects of constructive capitalization. Accounting Horizons, 11(2), 12–32. Retrieved from http://0-search.proquest.com.fama.us.es/docview/208896121?accountid=14744] methodology used by previous authors. We change how the lease term is estimated (more aligned with the final approved standard), and how the discount rate is obtained. Furthermore, we use a more comprehensive sample (646 quoted European companies). In line with previous research we find important systematic impacts on key balance sheet financial ratios (mainly leverage ratios), on a magnitude that depends on the operating lease intensity of the sector in which the entity operates. Our estimated impact is generally higher than that obtained in previous studies. The most affected sectors are retail, hotels and transportation. We do not find a consistent result with regard to the effect on profitability ratios.     

The temporal nature of legitimation: the case of IFRS8

Legitimation can operate on an episodic or continual basis [Suchman, M.C. (1995). Managing legitimacy: Strategic and institutional approaches. Academy of Management Review, 20(3), 571–610]. We examine the temporal legitimation of the International Accounting Standards Board (IASB)’s actions during the adoption and review of International Financial Reporting Standard (IFRS) 8 ‘Operating Segments’. We conceptualise the controversy surrounding IFRS8 as an episode when the IASB sought segmental reporting convergence with the US standard, Statement of Financial Accounting Standard 131. Interpreting evidence from 15 (20) semi-structured interviews undertaken in 2009 (2011), before (after) entities reported under IFRS8, reveals its adoption precipitated an episodic legitimacy threat from selected audiences to the actions of the IASB. We discuss the IASB's attempt to influence legitimation for this episode through commitment to a post-implementation review [IFRS Foundation. (2011). Post implementation reviews: Plan for developing the framework for conducting post-implementation reviews. IASB Board meeting February 2011. Retrieved July 27, 2011, from http://www.ifrs.org/NR/rdonlyres/3E1502E4-F1E8-4907-838B-FFB20C7268ED/0/PIR02111st2ndb04obs.pdf] of IFRS8. Interpreting legitimacy concerns across diverse audiences about specific actions of the IASB (the introduction of IFRS8) enables us to draw conclusions about the resilience of the IASB as a standard setting organisation, in itself.     

Sovereign Risk Contagion in East Asia: A Mixture of Time-Varying Copulas Approach

This study analyzes sovereign risk contagion between four East Asian economies (China, Hong Kong, Japan, and Korea) and its structural changes through the Global Financial Crisis (GFC) and the European Debt Crisis (EDC) by applying the mixture of time-varying copulas to those economies’ credit default swap (CDS) spreads.

This article first finds a strong contagion from the US and PIIGS economies to the East Asian sovereign CDS markets and intraregional contagion within the East Asian markets. Second, the impact of contagion is different according to whether it is measured by the linear (Gaussian) or the upper tail dependence. Third, Japan plays an important role in increasing the linear dependence whereas China and Korea are crucial in terms of the upper tail dependence. Lastly, the GFC has structurally increased the linear dependence but not the upper tail dependence between the East Asian sovereign CDS markets.     

Factors Affecting Retirement Mortality

Abstract

As many countries consider mandatory individual retirement accounts as their answer to a secure social security system, the question arises as to whether all workers can get true “market value” annuities when they retire. It is clear today that private-sector life annuities are priced assuming that the applicant is healthy—very healthy. Very little underwriting or risk classification now exists in the individual annuity marketplace. However, if a large percentage of the population were looking to annuitize their social security accounts upon retirement, there would be strong pressure for more risk classes in the annuity-pricing structure.

Even without the advent of individual accounts for social security, the authors of this paper feel there may be real market opportunities for more risk classification in the individual annuity market and the offering of “impaired life annuities.” Given that this pressure does or might soon exist, this paper reviews 45 recent research papers that look at factors that affect mortality after retirement. In particular, factors that seem to be important in predicting retirement mortality include age, gender, race and ethnicity, education, income, occupation, marital status, religion, health behaviors, smoking, alcohol, and obesity. for each factor, this paper gives highlights relative to the named factor of the impact expected from that variable as described in the 45 reviewed research papers.

The authors believe there is a wealth of information contained in the summaries that follow, and it is our sincere hope that this paper will cause an increased interest in a more broadly based risk classification structure for individual annuities.

Summaries of the 45 papers can be found at www.soa.org/sections/farm/farm.html.     

Price discovery in the presence of boundedly rational agents

In this paper we propose a sequential model of security trading which, compared to existing models, is extended along the notions of (Simon, H.A., A behavioral model of rational choice. Quart. J. Econ., 1955 Simon, HA. 1955. A behavioral model of rational choice. Quart. J. Econ., 64: 99–118.  [Google Scholar], 64, 99–118; Rubinstein, A., Modeling Bounded Rationality, Zeuthen Lecture Book Series, 1998 (MIT Press: Cambridge, MA), and Odean, T., Do investors trade too much? Am. Econ. Rev., 1999, 89(5), 1279–1298) by adding boundedly rational traders. Our results indicate that both momentum and mean-reversion in asset prices can be attributed to the presence of agents who are subject to systematic errors in the process of forecasting the liquidation value of a risky security. The length of the momentum period is inversely related to both the amount of information-based trading in the market and the rate at which asset specific information is learned by boundedly rational agents. Furthermore, the model allows explicitly to establish a link between the component of the bid–ask spread that can be explained by bounded rationality and both momentum and reversal.     

LARCH, Leverage, and Long Memory

We consider the long-memory and leverage properties of a modelfor the conditional variance of an observable stationary sequence X_t, where is the square of an inhomogeneous linear combination of X_s, s < t, withsquare summable weights b_j. This model, which we call linearautoregressive conditionally heteroskedastic (LARCH), specializes,when depends only on X_t–1, to theasymmetric ARCH model of Engle (1990, Review of Financial Studies3, 103–106), and, when depends only on finitely many X_s, to a version of the quadratic ARCH modelof Sentana (1995, Review of Economic Studies 62, 639–661),these authors having discussed leverage potential in such models.The model that we consider was suggested by Robinson (1991,Journal of Econometrics 47, 67–84), for use as a possiblylong-memory conditionally heteroskedastic alternative to i.i.d.behavior, and further studied by Giraitis, Robinson and Surgailis(2000, Annals of Applied Probability 10, 1002–1004), whoshowed that integer powers , =" BORDER="0">2 can have long-memory autocorrelations. We establish conditionsunder which the cross-autocovariance function between volatilityand levels, , decays in the manner of moving average weights of long-memory processes on suitable choiceof the b_j. We also establish the leverage property that h_t <0 for 0 < t k, where the value of k (which may be infinite)again depends on the b_j. Conditions for finiteness of thirdand higher moments of X_t are also established.     

Optimal execution strategies in limit order books with general shape functions

We consider optimal execution strategies for block market orders placed in a limit order book (LOB). We build on the resilience model proposed by Obizhaeva and Wang (2005 Obizhaeva, A and Wang, J. 2005. Optimal trading strategy and supply/demand dynamics, Preprint Available online at: http://www.rhsmith.umd.edu/faculty/obizhaeva/OW060408.pdf (accessed 16 February 2009)[Crossref] , [Google Scholar]) but allow for a general shape of the LOB defined via a given density function. Thus, we can allow for empirically observed LOB shapes and obtain a nonlinear price impact of market orders. We distinguish two possibilities for modelling the resilience of the LOB after a large market order: the exponential recovery of the number of limit orders, i.e. of the volume of the LOB, or the exponential recovery of the bid–ask spread. We consider both of these resilience modes and, in each case, derive explicit optimal execution strategies in discrete time. Applying our results to a block-shaped LOB, we obtain a new closed-form representation for the optimal strategy of a risk-neutral investor, which explicitly solves the recursive scheme given in Obizhaeva and Wang (2005 Obizhaeva, A and Wang, J. 2005. Optimal trading strategy and supply/demand dynamics, Preprint Available online at: http://www.rhsmith.umd.edu/faculty/obizhaeva/OW060408.pdf (accessed 16 February 2009)[Crossref] , [Google Scholar]). We also provide some evidence for the robustness of optimal strategies with respect to the choice of the shape function and the resilience-type.     

Capital reduction case law decisions and the development of the capital maintenance doctrine in late-nineteenth-century England

Incorporation with limited liability enabled companies to ‘lock-in’ their financial capital’ and then invest in the long-term, highly specific investments on which the modern industrial economy would be based. The level of benefit varied from country to country, according to the way that the concept of capital lock-in, or maintenance, was defined in the legal systems concerned.

In the UK, the concept was not well defined in early company legislation and challenges were raised through the courts during the late nineteenth century. Some of these, the ‘dividend cases’, have been quite widely considered in the literature but direct reductions of share capital, or capital reduction schemes, have received far less attention, even though they raised fundamental issues concerning long-term dividend positions, the accounting treatment of accumulated losses, depreciation and asset values and had important effects on the development of the capital maintenance doctrine and on shareholder class rights.

The purpose of this paper is to question whether this literature adequately captures judicial influences on the development of the capital maintenance doctrine in England during the latter part of the nineteenth century, given the limited attention that has been paid to date to the leading capital reduction cases.     

Practitioners' Corner

The first 150 words of the full text of this article appear below. The article by Christian Gourieroux and Razvan Sufana providesa complete characterization of two-factor affine diffusion termstructure models. The presentation of the article may seem forbiddingto the practitioner audience, so it is perhaps useful that thisinstallment of the column provide some context for the resultsof this article. Prominent among affine diffusion models in the term structureliterature are the Gaussian and square-root diffusion modelsof Vacisek (1977) and Cox, Ingersoll, and Ross (1985). The seminalcontribution of Duffie and Kan (1996) had been to provide anecessary and sufficient condition on the stochastic model toobtain the desirable property of "affine yields," whereby theyield of any zero-coupon bond is seen as a maturity-dependentaffine combination of a selected "basis" set of yields. SubsequentlyDuffie, Pan, and Singleton (2000) proved that the aforementionedcharacterization is even more general, both for the stochasticmodel that may . . . [Full Text of this Article]     

Do Personal Taxes Destroy Tax Shields? A Critique to Miller’s (1977) Proposal

We discuss the relevance of personal taxes on tax shields. Interest and taxes are the basis for defining an optimal capital structure. When personal taxes are greater than or equal to TS, an optimal capital structure does not exist.

We suggest that the approach proposed by Miller (1977) might understate the effect of personal taxes in the net TS and/or its associated net value. We consider the irrelevance of personal taxes on interest received by debtholders on the value of TS earned by the firm on interest paid. We conclude that Miller’s approach might be wrong and has some inconsistencies.     

Practitioners' Corner

The first 150 words of the full text of this article appear below. During the 1980s, the early stages of modeling financial timeseries focused on the striking stylized fact that while returnswere themselves not serially correlated, squared returns were.This history has been nicely documented in the influential bookby Taylor (1986) and, indeed, the opening chapters of contemporaryfinancial econometrics open with Engle (1982) and Bollerslev(1986) who provided a specific ARMA structure of squared returnsvia the celebrated [G]ARCH models. This general orientationin effect acknowledged that there was some room for predictingrisk, as measured by squared values or absolute values of returns,while at the same time maintaining the hypothesis that returnsthemselves were hardly predictable in keeping with some versionof market efficiency. However, this paradigmatic view has beenchallenged over the subsequent 20 years in at least three regards. First, with Nelson (1991), it has been widely acknowledged thatalthough GARCH modeling is about . . . [Full Text of this Article]