Informs Annual Meeting Phoenix 2018

INFORMS Phoenix – 2018

WB22

n WB22 North Bldg 130 Practice – Finance – Risk Management Contributed Session

n WB23 North Bldg 131A Financial Engineering Topic

Sponsored: Finance Sponsored Session Chair: Xuedong He, The Chinese University of Hong Kong, Shatin, Hong Kong Co-Chair: Nan Chen, Chinese University of Hong Kong, Shatin N. T, Hong Kong 1 - Profitability of Electronic Market Making and Latency Xuefeng Gao, Chinese University of Hong Kong, William M.W. Mong Engineering Building, Room 606, Shatin, Hong Kong This paper studies the profitability of electronic market making strategies and the impact of latency on market makers’ profits for large-tick assets. By analyzing the optimal market making problem using Markov Decision Processes, we provide simple conditions to identify when market making strategy is profitable. We also show that higher latency leads to reduced profits for market makers. Numerical experiments are conducted to illustrate the impact of latency and relative latency on the profitability of market making strategies. This is a joint work with Yunhan Wang. 2 - Addressing Systemic Risk Using Contingent Convertible Debt – A Network Analysis Yueliang Lu, UNC Charlotte, Charlotte, NC, United States, Aparna Gupta, Runzu Wang We construct a balance sheet based network model to study the interconnectedness of US banking system. After a simulation analysis of the buffer effect of contingent convertible (CoCo) debt in controlling contagion in the banking network under a theoretically motivated model, we use 13-F filings made to the US Securities and Exchange Commission (SEC) to calibrate the theoretical model. Our results demonstrate that CoCo debt conversion significantly reduces the average number of bank failures, decreases the CoVaR of the banking system, and thus, mitigates systemic risk. While CoCo debt with dual-trigger is not so efficient as a single trigger design in reducing individual bank failures, the former is more e?ective at protecting the surviving banks, which leads to improved stability from the perspective of the banking system. We claim that the different designs of CoCo triggers result in trade-offs for addressing systemic risk, which may be evaluated in a network model developed in this work. 3 - Portfolio Selection under Loss Aversion with a Mentally Adjusted Reference Point Moris Strub, The Chinese University of Hong Kong, Shatin, Hong Kong, Xuedong He Most models on portfolio selection under loss aversion make a strong assumption on what the reference point is or how it is formed. In this paper, we relax this assumption by proposing three models where the investor mentally adjusts an initial, exogenous reference point: A model of mental reference point updating, a model of a partially endogenous reference point and a model of a mentally optimal reference point. We find that optimal trading behavior is remarkably robust with respect to mental reference point formation and converges to the neoclassical prediction with increasing experience and sophistication of the investor. 4 - Dynamic Mean-risk Asset Allocation Xuedong He, The Chinese University of Hong Kong, Room 609 William M.W. Mong Engineering Bldg, Shatin, Hong Kong, Zhaoli Jiang In a market that consists of multiple stocks and one risk-free asset whose expected return rates and volatility are deterministic, we study a continuous-time mean-risk portfolio selection problem in which an agent is subject to a constraint that the expectation of her terminal wealth must exceed a target and minimizes the risk of her investment, which can be the variance or tail risk of her terminal wealth. Considering three types of expected terminal wealth target, we derive the equilibrium policy in closed form, and this policy is myopic and does not depend on the risk measure used by the agent nor on the agent’s evaluation period.

Chair: Tiantian Lin, Zhejiang University, Zhejiang Sheng, China 1 - Effect of Venture Capitalist Competition on Seed Funding for Supply Chains Joyaditya Laik, PhD Candidate, University of Pittsburgh, 241 Mervis Hall, Katz Business School, Pittsburgh, PA, 15260, United States Startup’s raise capital by various means. One of them is by appealing to a Venture Capitalist whose primary stake in the form is the equity he owns. We model a situation when there are two ‘types’ of VCs and study the effect on the equity shared when both VCs are present. We observe that the equity that’s given out is smaller with competition as compared to when there is no competition and that the equity demanded increases in the uncertainty of the potential market demand. 2 - Cooperative Resolution of Crises in Financial Networks Markku Kallio, Professor, Aalto Univertsity School of Business, Pohjoiskaari 17 D. 17, Helsinki, FIN-00200, Finland, Aein Khabazian We examine the financial network of systemically important banks as a cooperative game. Governments can act as facilitators enforcing incentives for banks to cooperate and prevent the escalation of a financial crisis. To achieve fair allocation of bailout costs, we use nucleolus which implies a possible subsidizing pattern among the banks. Our approach helps avoid moral hazard and free rider problems. For a demonstration, we use major European banks and a scenario which is linked to the adverse economic scenario used in 2016 EU-wide stress testing. Rescue performance is compared with several alternative non-cooperative approaches. 3 - A Linear Omega Portfolio Model with Optimizing Return Threshold Jing-Rung Yu, Professor, National Chi Nan University, 470 University Road, Puli, Nantou, 545, Taiwan, Paul Chiou, WenYi Lee The omega ratio incorporates both the upside profit and downside risk with considering a return threshold. Although the threshold can affect the effectiveness of the Omega portfolio model, its determination has not been thoroughly studied yet. A conventional fixed-value approach simplifies investor’s decision without taking economic dynamics into account. This study optimizes the threshold value in the Omega model under certain and uncertain return distributions. The empirical results using the daily returns of the S&P 500 Index composite stocks show that the proposed WOmega model yields lower loss values and better controlling the downside risk than the CVaR related counterparts. 4 - Pass-through of Commodity Price Shocks in Distribution Channels with Risk-averse Agents Phat Luong, Rutgers University, Piscataway, NJ, United States, Xiaowei Xu This paper studies how to allocate risk in distribution channels, in which a risk averse supplier faces commodity price shocks and a risk averse buyer faces downstream market uncertainty. The supplier can pass-through commodity price shocks to the buyer under a surcharge pricing system, which is widely used in the steel industry. We model the buyer-supplier relationship as either a Stackelberg leadership game or a Nash bargaining solution. By conducting variance analysis on commodity price shocks and market uncertainty, we derive the closed-form optimal pass-through rate of commodity price shocks, which minimizes the weighted total channel risk and maximizes the channel throughput. 5 - The Allocation of Financial Risk in a Supply Chain with Influence of Supply Chain Characteristics Tiantian Lin, Zhejiang University, Hangzhou, China, Gangshu Cai, Weihua Zhou Buyer financing from e-commerce platform and trade credit are two popular financing methods for e-commerce SMEs. The two represent different ways of risk allocation. To detect which kind of risk allocation is more efficient, and how supply chain features influence, we construct a supply chain with a retailer, a manufacturer and a distributor on a consignment basis. We find neither buyer financing nor trade credit always outperforms the other. And the supply chain features like leadership structure influences not only the efficiency of the same risk allocation, but also relative efficiency of different risk allocation.

448