Market Frictions Research Articles

Population aging, pensions, informality and labor market frictions in Lebanon. Reforms and policy choices

We evaluate the effects of population aging on the macroeconomic evolution of the Lebanese economy and the financial sustainability of its major pension schemes. We use an OLG model with labor market frictions as in de la Croix et al. (2013). Individuals are differentiated by their origin, age, gender, and education and choose the sector of activity, which implies that the size of the informal sector is endogenous. We assess the long-run implications of population aging and show that the public sector pension scheme is unsustainable. In contrast, the private sector scheme is insufficient to ensure decent living standards for the elderly. Finally, we evaluate the effects of two pension reforms. We first propose a mix of measures that guarantee the sustainability of the public sector scheme. Then, we evaluate the impact of the pension reform introduced in December 2023 and of an alternative reform aiming at increasing the size of the private sector scheme to improve the living standards for the elderly.

Offshoring, firm-level adjustment and labor market outcomes

This paper studies how the China shock affects unemployment rates and wage inequality across high-skilled and low-skilled workers in the United States, with particular emphasis on the dynamic and general equilibrium channels of firms' production locations and entry decisions. To shed light on the subject, I build a two-country trade-in-task model with firm heterogeneity, search-and-matching labor market frictions, and firms' endogenous selections into entry and offshoring. The model, consistent with evidence from vector autoregression analyses, uncovers important dynamics with implications for the impact of the China shock on U.S. worker inequality. Namely, it shows association between a decrease in offshoring costs and a short-lived increase in low-skilled unemployment in the source country, a longer-term decline in high-skilled unemployment, a transient expansion of the wage gap between high- and low-skilled workers, and an increase in firm entry.

Portfolio management under capital market frictions: a grey clustering approach

International portfolio management is influenced by the existence of “frictions”, factors or events that interfere with trade, which are linked in financial literature to market-specific factors, such as available information, restrictions, investor protection, or market liquidity. Given the wide variety of factors that can be included in these categories, scientific studies typically focus on a reduced number of indicators at a time in order to offer an in depth analysis of their impact. We offer a consolidated view of the perspectives observed in financial literature by proposing a novel index for market frictions that includes all these four components and rank fifteen post-communist East European capital markets based on their index values. We then constructed various scenarios by assuming different levels of importance for the criteria used in index construction. By employing grey clustering analysis, we cluster these capital markets into three categories—strongly recommended, recommended with some reserve, and not recommended—based on the importance given by the decision maker to these factors. The results show that some of the studied markets are in the same cluster, irrespective of the chosen scenario. The only market always included in the “strongly recommended” category is Hungary, indicating that it is a good investment option for international participants. Bulgaria and Slovakia are always regarded as “recommended with reserve” markets, whereas the Republic of Moldova is part of the “not recommended” category. The other markets show a degree of variability that can be explained by different investor perspectives. This study contributes to the existing literature by combining the advantages of grey clustering and portfolio analysis. Investors can use this approach during the decision-making process related to their investments.

Measuring Portfolio Gains: The Case of Earnings Announcement Trading Signals

ABSTRACT This study offers solutions to help address practical issues researchers generally overlook when assessing gains from a trading signal. Specifically, the methodologies used in previous research generally ignore investor risk aversion when forming portfolios, do not update portfolios as signals arrive, exploit look-ahead biases, do not assess the incremental gains of a new signal, and do not consider market frictions. We examine trading signals based on post-earnings announcement drift (PEAD), the earnings announcement premium (EAP), and earnings announcement rescheduling (RES). Using our proposed approach, we find that portfolios that incorporate the individual signals produce higher Sharpe ratios than equal-weighted portfolios; however, the gains for each signal are concentrated to a few days around the announcement. The EAP and RES signals do not provide incremental portfolio gains over the PEAD signal. After considering market frictions, portfolio performance rapidly attenuates and becomes similar to the SPY ETF as the portfolio size increases. JEL Classifications: G12; G14; G17.

Survey Data and Subjective Beliefs in Business Cycle Models

Abstract This paper develops a theory of subjective beliefs that departs from rational expectations, and shows that biases in household beliefs have quantitatively large effects on macroeconomic aggregates. The departures are formalized using model-consistent notions of pessimism and optimism which are supported by extensive time-series and cross-sectional evidence from household surveys. The role subjective beliefs play in aggregate fluctuations is quantified in a business cycle model with goods and labour market frictions. Consistent with the survey evidence, an increase in pessimism generates upward biases in unemployment and inflation forecasts and lowers economic activity. The underlying belief distortions reduce aggregate demand and propagate through frictional goods and labour markets. As a by-product of the analysis, solution techniques that preserve the effects of time-varying belief distortions in the class of linear solutions are developed.

Ecologies of friction in digital platform investment

ABSTRACT Digital platforms are underpinned by the ideal of a frictionless market, obscuring the simultaneous practices of market monopolisation and the restriction of consumer choice and movement. This concurrent removal and erection of barriers to participation triggers ecosystemic responses such as individual adaptations and establishing alternative organisations to counter the progression of these ‘walled gardens’. In this article, we contribute to theorising ecologies of friction in the platform economy, drawing on Tsing’s friction in the creation of global connections, Orbach’s friction paradox, and Bateson’s ecological epistemology. Analysing a European short-term rental platform cooperative’s difficult launch, we ask: How do frictions emerge on alternative platforms in the digital economy, and what effect do they have on prefiguring the platform business? Frictions become apparent in platform investment, a complex resource-allocating relationship binding together multiple stakeholders, laden with expectations about the future. We highlight the interconnected frictions of individual investment into platform work, collective investment into platform participation, and resource investment into the business model. These are bound with platform organising, community development, and managing scale as the cooperative tries to prefigure a future platform economy in establishing its current practice. We contribute by extending the concept of ecologies of friction in connecting individual and collective investment with ideas around platform growth. We illustrate how all platform economy actors – participants and platforms alike – are entangled in frictions. We suggest that alternative platforms’ struggles are largely caused by the impossibility of escaping the broader ecosystemic dynamics established by dominant platform imaginaries.

Fairness and competition in a bilateral matching market

This paper analyzes fairness and bargaining in a dynamic bilateral matching market. Traders from both sides of the market are pairwise matched to share the gains from trade. The bargaining outcome depends on the traders' fairness attitudes. In equilibrium fairness matters because of market frictions. But, when these frictions become negligible, the equilibrium approaches the Walrasian competitive equilibrium, independently of the traders' inequity aversion. Fairness may yield a Pareto improvement; but also the contrary is possible. Overall, the market implications of fairness are very different from its effects in isolated bilateral bargaining.

Corporate social responsibility and labor investment efficiency: evidence from China

PurposeWe expect to provide a complete theoretical framework and large sample evidence on the impact of corporate social responsibility (CSR) on the efficiency of labor investment. We also hope to provide micro-evidence based on labor investment behavior for the two-sided impact of corporate CSR behavior.Design/methodology/approachThis paper measures labor investment efficiency by estimating the difference between actual and expected net hiring of enterprises. CSR is measured on the basis of the CSR score of Chinese listed companies published by Hexun.com. A regression model is constructed to analyze the relationship between CSR and labor investment efficiency. Possible endogeneity problems are controlled by lagging independent variables, propensity score matching method and difference-in-difference method.FindingsResults show that CSR can improve labor investment efficiency by reducing over-hiring and under-hiring in emerging markets. The existence of the mediating effect of agency cost, information disclosure quality and employment fluctuation confirms that CSR improves labor investment efficiency through two mechanisms of corporate governance and labor market friction. The improvement effect of CSR on labor investment efficiency is more significant in non-state-owned, high CEO shareholding ratio and high-average urban wage enterprises.Originality/valueIn conclusion, our study is an important supplement to the existing research on the factors affecting labor investment efficiency. Our research conclusions will be helpful for enterprises in developing countries or enterprises in labor-intensive industries to improve labor investment inefficiency. The conclusion of the mechanism analysis in this paper provides more complete and reliable microscopic evidence for accurately identifying the specific path of CSR's impact on labor investment efficiency. This paper verifies the positive impact of CSR from the perspective of labor investment efficiency in the context of a developing country, which provides evidence for the theoretical conflicts related to CSR based on the effectiveness of enterprise labor investment decisions.

Firm value adjustment speed through financial friction in the presence of earnings management and productivity growth: evidence from emerging economies

This study investigates the role of financial frictions on firm value within the framework of earnings management, including the impact of productivity growth. In contrast to prior studies, the present study employed an autoregressive model to examine the temporal dynamics of the variables to determine their short-term and long-term connection patterns. The results of the study indicate a negative association between financial frictions and firm value. Accrual earnings management, a practice employed by organizations to enhance their profit margins, serves as a mediator between financial frictions and firm value. This mediation of earnings management alleviates the adverse impact of financial frictions. The enhancement of productivity growth amplifies the conditional, indirect influence of earnings management. Moreover, this study reveals that financial frictions have a significant influence in the short-term, leading to overestimation of factor loadings. However, this impact stabilizes over time in the long run. Financial market frictions have the most prominent impact on firm value compared to the other two forms of frictions, namely, macroeconomic frictions and microeconomic frictions. Larger firms are more inclined to attain higher firm value than smaller enterprises. Managers can enhance firm value by exerting control over the influence of financial frictions in the economy through earnings management. The effectiveness of this strategy is contingent upon the level of productivity growth.

Long-run consequences of informal elderly care and implications of public long-term care insurance

We estimate a dynamic structural model of labor supply, retirement, and informal caregiving to study short and long-term costs of informal caregiving in Germany. Incorporating labor market frictions and the German tax and benefit system, we find that in the absence of Germany’s public long-term insurance scheme, informal elderly care has adverse and persistent effects on labor market outcomes and, thus, negatively affects lifetime earnings and future pension benefits. These consequences of caregiving are heterogeneous and depend on age, previous earnings, and institutional regulations. Policy simulations suggest that while public long-term care insurance policies are fiscally costly and induce negative labor market effects, they can largely offset the personal costs of caregiving and increase welfare, especially for low-income individuals.

Firms’ financing choice between short-term and long-term debts: Are they substitutes?

When selecting debt to finance their operations and investments, companies face crucial decisions regarding the appropriate types of debt. Despite the classic Modigliani–Miller (1958) capital structure irrelevance result, real-world market frictions can significantly impact a firm's capital structure decisions. This reality means that one debt type is not a perfect substitute for another, due to differences in important factors including maturity structures, funding purposes, rollover risks, and funding costs.

Interaction effects in the cross-section of country and industry returns

We comprehensively examine the interaction effects in the cross-sectional predictability of country and industry returns. Using nearly five decades of data from 68 countries, we construct all possible double-sorted portfolios based on 44 portfolio characteristics and uncover numerous significant interactions. An out-of-sample value-weighted strategy that selects the top long-short country (industry) interactions generates a monthly World CAPM alpha of 0.33% (0.62%) with a Sharpe ratio of 0.58 (0.75). The strongest interactions stem from implementing momentum and technical analysis signals in small and illiquid countries or industries. Furthermore, the return patterns mainly emanate from frontier and weakly integrated markets—highlighting the role of market frictions and segmentation in the occurrence of abnormal returns. Consistent with these interpretations, the interactions decline over time as global markets mature and become more integrated.

Diversifying and hedging REIT portfolios with cryptocurrencies: Evidence from global and regional REIT indices

Hedging the financial risk of portfolios of securitized real estate assets is daunting because of the unique nature of the underlying assets and because no direct market exists to trade on property-related derivatives. In this paper, we conduct a global study of the diversification and risk mitigation benefits of cryptocurrencies for REIT stocks. Specifically, we examine the dynamic relationship between Bitcoin and REIT indices obtained from multiple countries and regions of the world. We also explore whether portfolios of REIT stocks that are hedged with Bitcoin futures obtain significant improvement in portfolio risk mitigation and return performance. Furthermore, given that Bitcoin and REIT stocks are prone to large volatility swings, we examine the nature of the tail dependences in the multivariate distributions of our REIT indices universe and Bitcoin using Archimedean copula functions. Lastly, we compare the market risk of Bitcoin-hedged REIT portfolios to the unhedged portfolios of REIT stocks using value-at-risk. We find region-specific benefits from using Bitcoin to hedge REIT exposure. Furthermore, we show that using Bitcoin to dynamically hedged REIT portfolios had minimal impact on the bivariate and multivariate joint distributions of REIT portfolios. We also find evidence of region-specific reductions in the market risk exposure of dynamically hedged REIT portfolios relative to unhedged and naively hedged REIT portfolios. We posit that Bitcoin could improve the mean-variance frontiers of REIT investors in countries with higher market friction and lower global integration.

Robust portfolio selection with smart return prediction

Return prediction and portfolio decision are closely connected steps in forming optimal portfolios. However, existing studies often separate return prediction from portfolio decisions or overlook the high sensitivity of optimal portfolios to estimated returns, leading to poor out-of-sample performance. To address these two issues simultaneously, this paper proposes a robust portfolio framework that optimizes parameters in return prediction by maximizing robust mean–variance utility. The proposed framework effectively combines return prediction and portfolio decisions while mitigating the uncertainty in return prediction. Empirical analysis on S&P500 constituents demonstrates that, compared to the benchmarks, the proposed framework achieves lower risk and higher risk-adjusted returns, originating from more stable weight estimation and diversified portfolios. Further, we uncover that the market friction characteristics considerably contribute to the proposed strategies’ performance. Our results suggest that integrating return prediction with the robust mean–variance models can significantly improve portfolio performance.

Cumulative impacts in environmental justice: Insights from economics and policy

Disparities in health and socioeconomic well-being are a result of the cumulative impacts from multiple coinciding environmental, health, and social stressors. Addressing cumulative impacts is seen as a crucial step toward environmental justice (EJ). Using the case of the United States, we compare different methods to operationalize the concept for real-world application. We empirically demonstrate the extent to which non-White and low-income neighborhoods are subject to a wide array of burdens and how these burdens are reflected in national EJ indices and housing prices. We find that non-White and low-income neighborhoods are correlated with measures of multiple environmental burdens and social stressors but correlate to a lesser extent with natural disaster risk. Two existing EJ indices are only moderately correlated and more correlated with low-income status than with percent non-White. Models that employ the housing market for benefits estimation may fail to capture preferences to avoid multiple stressors due to issues including data availability and market frictions, such as discrimination. Finally, we highlight the challenges in cumulative impacts analysis for research and policy-making.

CAPITAL FLOWS AND INSTITUTIONAL QUALITY: A SYSTEMATIC LITERATURE REVIEW

The understanding of what drives capital flows is continually evolving. Earlier theories provided support for the role of macroeconomic factors, however, the drivers expanded to include non-macroeconomic factors following the Lucas (1990) paradox, which spurred interest towards examining the role of institutional quality and, in more recent years, capital market frictions. While other reviews of capital flow literature have concentrated on macroeconomic drivers, this review focuses on institutional factors and frictions and delves into three types of flows, as drivers can vary by type of flow. The literature is vast on drivers of foreign direct investment (FDI) while drivers of other types of capital flows have been less studied, and evidence remains scant. There is evidence of institutional quality helping to explain the Lucas paradox. Based on the literature reviewed in this paper, many institutional factors are important for FDI. Law and order and military in politics are notably important for both FDI and portfolio debt. Findings for portfolio equity are limited. On capital market frictions, the empirical evidence shows that distance; economic ties; and having a common language, border, and colonial past help explain capital flows; with distance driving all three types of capital flows. This review will help inform further research and policies aimed at attracting and retaining foreign capital, especially in developing economies that need such flows for economic development and poverty alleviation.

Efficiency and financial risk management practices of microfinance institutions

AbstractMicrofinance institutions (MFIs) have evolved in different and complex ways to solve various market frictions, with some of them providing a wide range of financial products and using different lending technologies to reach poor and underserved populations. As a result, some MFIs are more efficient than others, but are efficiency gains aligned with risk management practices? The specific characteristics of the microfinance industry make the answer to this question less obvious than that of commercial banks. This paper tries to shed light on these issues by analysing the efficiency and risk management of MFIs and describing the potential implications of these relationships for the microfinance industry. After considering several measures of financial risk management ratios commonly used in the microfinance literature, our results show that cost efficiency improves asset quality and solvency of MFIs, but also reduces the need for holding idle cash or liquid assets. The results of this paper can help academics, policymakers, and regulators to better understand the impact of cost efficiency on financial risks management practices in the microfinance industry.

Decentralized finance (DeFi) markets for startups: search frictions, intermediation, and the efficiency of the ICO market

This paper examines the efficiency of the Initial Coin Offering (ICO) market through a search-theoretical lens. Search intensity associated with the process of identifying valuable startups is increasing in market granularity. DLT increases market granularity because asset tokenization lowers entry barriers. Lower-end entrants, however, increase aggregate search intensity but may lack search skills. The resulting search-related inefficiency creates a niche for intermediaries or institutional investors that specialize on search. Consistent with the theory, specialized crypto funds increase ICO market efficiency by reducing search frictions, inter alia, by shortening the time-to-funding and increasing the funding amount. At the same time, crypto funds extract sizable economic rents for their intermediation services. Overall, the study relates to the general trade-off between centralization and decentralization in entrepreneurial finance. It suggests that market frictions specific to early-stage crowdfunding of entrepreneurship may prevent “perfectly” Decentralized Finance (DeFi) markets from functioning efficiently.

Early exercise, implied volatility spread and future stock return: Jumps bind them all

AbstractWe find that early exercise premiums of exchange‐traded single‐stock American puts, in excess of the GBM‐world premium, can negatively predict future stock returns. Simulations suggest that asset‐value jumps, especially the mean jump‐size, can positively drive this excess premium, while jump‐size can also negatively induce the implied volatility (IV) spread of equivalent American option‐pairs. Empirically, controlling for the effect of jump‐size in excess premiums, the premium loses its predictive power. Furthermore, controlling for the excess premium or jump‐size, IV spreads' predictability shown in the literature also diminishes. Our evidence survives under alternative explanations like informed trading, stock mispricing or market frictions.

Almost Perfect Shadow Prices

Shadow prices simplify the derivation of optimal trading strategies in markets with transaction costs by transferring optimization into a more tractable, frictionless market. This paper establishes that a naïve shadow price ansatz for maximizing long-term returns, given average volatility yields a strategy that is, for small bid–ask spreads, asymptotically optimal at the third order. Considering the second-order impact of transaction costs, such a strategy is essentially optimal. However, for risk aversion different from one, we devise alternative strategies that outperform the shadow market at the fourth order. Finally, it is shown that the risk-neutral objective rules out the existence of shadow prices.