New Economics Papers
on Financial Markets
Issue of 2005‒01‒16
eleven papers chosen by
Erik Schloegl

  1. On the Existence of Linear Equilibria in the Rochet-Vila Model of Market Making By Georg Nöldeke; Thomas Tröger
  2. The Consumption-Based Determinants of the Term Structure of Discount Rates By Christian Gollier
  3. A Copula-Based Autoregressive Conditional Dependence Model of International Stock Markets By Rob van den Goorbergh
  4. Behavioral Biases of Dealers in U.S. Treasury Auctions By David Goldreich
  5. Order Flow and the Formation of Dealer Bids: An Analysis of Information and Strategic Behavior in the Government of Canada Securities Auctions By Samita Sareen; Ali Hortacsu
  6. Money Illusion in the Stock Market: The Modigliani-Cohn Hypothesis By Randolph B. Cohen; Christopher Polk; Tuomo Vuolteenaho
  7. Mimicking Portfolios with Conditioning Information By Wayne E. Ferson; Andrew F. Siegel; Pisun (Tracy) Xu
  8. Weak and Semi-Strong Form Stock Return Predictability Revisited By Wayne E. Ferson; Andrea Heuson; Tie Su
  9. Consumption Risk and the Cost of Equity Capital By Ravi Jagannathan; Yong Wang
  10. Forecasting Realized Volatility Using a Long Memory Stochastic Volatility Model: Estimation, Prediction and Seasonal Adjustment By Rohit Deo; Clifford Hurvich; Yi Lu
  11. Tracing the Source of Long Memory in Volatility By Rohit Deo; Mengchen Hsieh; Clifford Hurvich

  1. By: Georg Nöldeke; Thomas Tröger
    Abstract: This paper derives necessary and sucient conditions for the existence of linear equilibria in the Rochet-Vila model of market making. In contrast to most previous work on the existence of linear equilibria in models of market making, we do not impose independence of the underlying random variables. For distributions that are determined by their moments we show that a linear equilibrium exists if and only if the joint distribution of noise trade and asset payoff is elliptical.
    Keywords: Market Microstructure, Market Making, Linear Equilibria
    JEL: G14 D82
    Date: 2004–10
  2. By: Christian Gollier
    Abstract: The efficient rate of return of a zero-coupon bond with maturity t is determined by our expectations about the mean (+), variance (-) and skewness (+) of the growth of aggregate consumption between 0 and t. The shape of the yield curve is thus determined by how these moments vary with t. We first examine growth processes in which a higher past economic growth yields a first-degree dominant shift in the distribution of the future economic growth, as assumed for example by Vasicek (1977). We show that when the growth process exhibits such a positive serial correlation, then the yield curve is decreasing if the representative agent is prudent (u'''> 0), because of the increased risk that it yields for the distant future. A similar definition is proposed for the concept of second-degree stochastic correlation, as observed for example in the Cox-Ingersoll-Ross model, with the opposite comparative static property holding under temperance (u''''< 0), because the change in downside risk (or skweness) that it generates. Finally, using these theoretical results, we propose two arguments in favor of using a smaller rate to discount cash-flows with very large maturities, such as those associated to global warming or nuclear waste management.
    Keywords: stochastic dominance, yield curve, far distant future, cost-benefit analysis, prudence, temperance, downside risk
    JEL: E43 G12 Q51
    Date: 2005
  3. By: Rob van den Goorbergh
    Abstract: This paper investigates the level and development of cross-country stock market dependence using daily returns on stock indices. The use of copulas allows us to build exible models of the joint distribution of stock index returns. In particular, we apply univariate AR(p)-GARCH(1,1) models to the margins with possibly skewed and fat tailed return innovations, while modelling the dependence between markets using parametric families of copulas which offer various alternatives to the commonly assumed normal dependence structure. Moreover, the dependence across stock markets is allowed to vary over time through a GARCH-like autoregressive conditional copula model. Using synchronous daily returns on U.S., U.K., and French stock indices, we find strong evidence that the conditional dependence between pairs of each of these markets varies over time. All market pairs show high levels of dependence persistence. The performance of the copula-based approach is compared with Engle's (2002) dynamic conditional correlation model and found to be superior.</td></tr> <tr> <td valign="top" class="txt">download: <span class="txtblue"><a href="bin/doc/Working%20Paper%20No.%2022-2004_tcm12-49221.pdf" title="Download Engelse versie">Engelse versie</a></span> | <span class="txtblue"><a href="#" onClick="popup2('/webForms.nsf/AanvraagPublicatie?openForm&org=DNB&lang=nl&titel=nr 022 - A Copula-Based Autoregressive Conditional Dependence Model of International Stock Markets','AanvraagPublicatie',600,550);" title="Bestel">bestel</a></span>
    Date: 2004–12
  4. By: David Goldreich (London Business School and CEPR)
    Abstract: This paper provides evidence of bounded rationality by large dealers in U.S. Treasury auctions. I argue that these dealers use a heuristic of yield-space bidding which leads to biases manifested in three ways: they submit dominated bids, i.e., those that could be improved without raising the bidding price; they bid in a manner that disregards the unevenly spaced price grid; and they round bids in yield space. Consistent with bounded rationality, I show that bidders are less susceptible to bias when the cost of suboptimal bidding is high. While the literature provides substantial evidence of behavioral biases among individual investors, they are less well documented for large sophisticated institutions that are likely to be important for setting asset prices. These primary bond dealers who regularly bid for billions of dollars in Treasury bill auctions are precisely such economic agents.
    Keywords: Treasury auctions, Behavioral finance
    JEL: H63 H74 D44
    Date: 2004–12
  5. By: Samita Sareen (Duke University); Ali Hortacsu (University of Chicago)
    Abstract: Using data on Government of Canada securities auctions, this paper shows that in countries where direct access to primary issuance is restricted to government securities dealers, Order-flow" information is a key source of private information for these security dealers. Order-flow information is revealed to a security dealer through his interactions with customers, who can place bids in the auctions only through the security dealer. Since each dealer interacts with a different set of customers, they, in effect, see different portions of the market demand and supply curves, leading to differing private inferences of where the equilibrium price might.
    Keywords: Treasury auctions, Behavioural finance
    JEL: D82 G14 L88
    Date: 2004–12
  6. By: Randolph B. Cohen; Christopher Polk; Tuomo Vuolteenaho
    Abstract: Modigliani and Cohn [1979] hypothesize that the stock market suffers from money illusion, discounting real cash flows at nominal discount rates. While previous research has focused on the pricing of the aggregate stock market relative to Treasury bills, the money-illusion hypothesis also has implications for the pricing of risky stocks relative to safe stocks. Simultaneously examining the pricing of Treasury bills, safe stocks, and risky stocks allows us to distinguish money illusion from any change in the attitudes of investors towards risk. Our empirical resuts support the hypothesis that the stock market suffers from money illusion.
    JEL: G12 G14 N22
    Date: 2005–01
  7. By: Wayne E. Ferson; Andrew F. Siegel; Pisun (Tracy) Xu
    Abstract: Mimicking portfolios have long been useful in asset pricing research. In most empirical applications, the portfolio weights are assumed to be fixed over time, while in theory they may be functions of the economic state. This paper derives and characterizes mimicking portfolios in the presence of predetermined state variables, or conditioning information. The results generalize and integrate multifactor minimum variance efficiency (Fama, 1996) with conditional and unconditional mean variance efficiency (Hansen and Richard (1987), Ferson and Siegel, 2001). Empirical examples illustrate the potential importance of time-varying mimicking portfolio weights and highlight challenges in their application.
    JEL: G1 G10 G11 G12 G14
    Date: 2005–01
  8. By: Wayne E. Ferson; Andrea Heuson; Tie Su
    Abstract: This paper makes indirect inference about the time-variation in expected stock returns by comparing unconditional sample variances to estimates of expected conditional variances. The evidence reveals more predictability as more information is used, and no evidence that predictability has diminished in recent years. Semi-strong form evidence suggests that time-variation in expected returns remains economically important.
    JEL: G1 G11 G12 G14
    Date: 2005–01
  9. By: Ravi Jagannathan; Yong Wang
    Abstract: We demonstrate, using data for the period 1954-2003, that differences in exposure to consumption risk explains cross sectional differences in average excess returns (cost of equity capital) across the 25 benchmark equity portfolios constructed by Fama and French (1993). We use yearly returns on stocks to take into account well documented within year deterministic seasonal patterns in returns, measurement errors in the consumption data, and possible slow adjustment of consumption to changes in wealth due to habit and prior commitments. Consumption during the fourth quarter is likely to have a larger discretionary component. Further, given the availability of more leisure time during the holiday season and the ending of the tax year in December, investors are more likely to review their asset holdings and make trading decisions during the fourth quarter. We therefore match the growth rate in the fourth quarter consumption from one year to the next with the corresponding calendar year return when computing the latter's exposure to consumption risk. We find strong support for our consumption risk model specification in the data.
    JEL: G12
    Date: 2005–01
  10. By: Rohit Deo (New York University); Clifford Hurvich (New York University); Yi Lu (New York University)
    Abstract: We study the modeling of large data sets of high frequency returns using a long memory stochastic volatility (LMSV) model. Issues pertaining to estimation and forecasting of large datasets using the LMSV model are studied in detail. Furthermore, a new method of de-seasonalizing the volatility in high frequency data is proposed, that allows for slowly varying seasonality. Using both simulated as well as real data, we compare the forecasting performance of the LMSV model for forecasting realized volatility to that of a linear long memory model fit to the log realized volatility. The performance of the new seasonal adjustment is also compared to a recently proposed procedure using real data.
    Keywords: Realized Volatility, Long Memory Stochastic Volatility Model, High Frequency Data, Seasonal Adjustment
    JEL: C1 C2 C3 C4 C5 C8
    Date: 2005–01–07
  11. By: Rohit Deo (New York University); Mengchen Hsieh (New York University); Clifford Hurvich (New York University)
    Abstract: We study the effects of trade duration properties on dependence in counts (number of transactions) and thus on dependence in volatility of returns. A return model is established to link counts and volatility. We present theorems as well as a conjecture relating properties of durations to long memory in counts and thus in volatility. We then apply several parametric duration models to empirical trade durations and discuss our findings in the light of the theorems and conjecture.
    JEL: C1 C2 C3 C4 C5 C8
    Date: 2005–01–13

This issue is ©2005 by Erik Schloegl. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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