New Economics Papers
on Financial Markets
Issue of 2005‒02‒27
seven papers chosen by
Erik Schloegl

  1. On the Design of Artificial Stock Markets By Boer-Sorban, K.; Bruin, A. de; Kaymak, U.
  2. 09/11 on the USD/EUR Foreign Exchange Market By Mende, Alexander
  3. Why is Long-Horizon Equity Less Risky? A Duration-Based Explanation of the Value Premium By Martin Lettau; Jessica Wachter
  4. "The Genesis and the Development of the Pre-war Japanese Stock Market" By Yasushi Hamao; Takeo Hoshi; Tetsuji Okazaki
  5. A General Benchmark Model for Stochastic Jump Sizes By Morten Christensen; Eckhard Platen
  6. Asset Price Dynamics with Time-Varying Second Moment By Carl Chiarella; Xue-Zhong He; Duo Wang
  7. Capital Asset Pricing for Markets with Intensity Based Jumps By Eckhard Platen

  1. By: Boer-Sorban, K.; Bruin, A. de; Kaymak, U. (Erasmus Research Institute of Management (ERIM), RSM Erasmus University)
    Abstract: Artificial stock markets are designed with the aim to study and understand market dynamics by representing (part of) real stock markets. Since there is a large variety of real stock markets with several partially observable elements and hidden processes, artificial markets differ regarding their structure and implementation. In this paper we analyze to what degree current artificial stock markets reflect the workings of real stock markets. In order to conduct this analysis we set up a list of factors which influence market dynamics and are as a consequence important to consider for designing market models. We differentiate two categories of factors: general, well-defined aspects that characterize the organization of a market and hidden aspects that characterize the functioning of the markets and the behaviour of the traders.
    Keywords: Market microstructure;financial markets;agent-based computational economics;artificial stock markets;uncertainty modeling;
    Date: 2005–02–18
  2. By: Mende, Alexander
    Abstract: We study the relationship between foreign exchange trading activity and volatility on the USD/EUR foreign exchange market on the basis of a unique data set around the events of 09/11/2001. We find that volatility and bid-ask spreads are by far larger at that time, but the shock is not persistent. The positive correlation between volume and volatility does not break up, but intensifies strongly indicating the arrival of new information and increased price risk. We conclude that the USD/EUR foreign exchange market maintains its liquid structure and its efficient processing of exogenous shocks.
    Keywords: foreign exchange, market microstructure, liquidity, sudden events
    JEL: F31 G14 G15
    Date: 2005–02
  3. By: Martin Lettau; Jessica Wachter
    Abstract: This paper proposes a dynamic risk-based model that captures the high expected returns on value stocks relative to growth stocks, and the failure of the capital asset pricing model to explain these expected returns. To model the difference between value and growth stocks, we introduce a cross-section of long-lived firms distinguished by the timing of their cash flows. Firms with cash flows weighted more to the future have high price ratios, while firms with cash flows weighted more to the present have low price ratios. We model how investors perceive the risks of these cash flows by specifying a stochastic discount factor for the economy. The stochastic discount factor implies that shocks to aggregate dividends are priced, but that shocks to the time-varying price of risk are not. As long-horizon equity, growth stocks covary more with this time-varying price of risk than value stocks, which covary more with shocks to cash flows. When the model is calibrated to explain aggregate stock market behavior, we find that it can also account for the observed value premium, the high Sharpe ratios on value stocks relative to growth stocks, and the outperformance of value (and underperformance of growth) relative to the CAPM.
    JEL: G1
    Date: 2005–02
  4. By: Yasushi Hamao (Marshall School of Business, University of Southern California); Takeo Hoshi (Graduate School of International Relations and Pacific Studies, University of California, San Diego); Tetsuji Okazaki (Faculty of Economics, University of Tokyo)
    Abstract: This paper examines the development of the Tokyo Stock Exchange since its inception in 1878 to the mid-1930s. Special attention is paid to the increases in the number of listed stocks throughout this period. By the mid-1930s, the Tokyo Stock Exchange had grown to a market bigger (measured relative to GDP) than many contemporary stock exchanges in major economies. Even compared with the stock exchanges in major countries today, the pre-war Tokyo Stock Exchange was quite large. New listings in the spot market section of the Tokyo Stock Exchange were not restricted for most of this period. Our regression analysis reveals that many firms decided to list their stocks on the Tokyo Stock Exchange as they became older and bigger. The commercial code change in 1911, which increased the protection of outside shareholders, also had a positive impact on the listings on the Tokyo Stock Exchange. The Tokyo Stock Exchange reform of 1918 that aimed at standardization of the spot transactions increased the listings on the Exchange. The analysis also suggests that in the earlier period, there was a "home bias" that the companies located in the Eastern part of Japan (closer to the Tokyo Stock Exchange) were more likely to be listed in the Tokyo Stock Exchange, but the effect diminished after the Exchange reform of 1918.
    Date: 2005–02
  5. By: Morten Christensen; Eckhard Platen (School of Finance and Economics, University of Technology, Sydney)
    Abstract: This paper extends the benchmark framework of Platen (2002) by introducing a sequence of incomplete markets, having uncertainty driven by a Wiener process and a marked point process. By introducing an idealized market, in which all relevant economical variables are observed, but may not all be traded, a generalized growth optimal portfolio (GOP) is obtained and calculated explicitly. The problem of determining the GOP is solved in a general setting which extends existing treatments and provides a clear link to the market prices of risk. The connection between traded securities, arbitrage and market incompleteness is analyzed. This provides a framework for analyzing the degree of incompleteness associated with jump processes, a problem well-known from insurance and credit risk modeling. By staying under the empirical measure, the resulting benchmark model has potential advantages for various applications in finance and insurance.
    Date: 2004–11–01
  6. By: Carl Chiarella (School of Finance and Economics, University of Technology, Sydney); Xue-Zhong He (School of Finance and Economics, University of Technology, Sydney); Duo Wang
    Abstract: We develop a simple behavioural asset pricing model with fundamentalists and chartists to study price behaviour in financial markets. Within our model, the market impact of the weighting process of the conditional mean and variance of the chartists and investors' reactions are analysed. Price dynamics of the deterministic model under/over-reactions are analyzed. It shows different price dynamics and routes to complicated price behaviour when the chartists act as either trend followers or contrarians. It is found that (in a separate paper Chiarella et al (2004)) this analysis can be used to establish some connections between the statistical properties of the nonlinear stochastic system (such as distribution density and autocorrelation patterns of returns, in particular the stylised facts, such as fat tails, skewness, high kurtosis and long memory, observed in high frequency financial data) and the stability and bifurcation of the underlying deterministic system are established.
    Keywords: fundamentalists; chartists, stability; bifurcation; investors' under- and over-reactions; stylized facts
    JEL: D83 D84 E21 E32 C60
    Date: 2004–11–01
  7. By: Eckhard Platen (School of Finance and Economics, University of Technology, Sydney)
    Abstract: This paper proposes a unified framework for portfolio optimization, derivative pricing, modeling and risk measurement in financial markets with security price processes that exhibit intensity based jumps. It is based on the natural assumption that investors prefer more for less, in the sense that for two given portfolios with the same variance of its increments, the one with the higher expected increment is preferred. If one additionally assumes that the market together with its monetary authority acts to maximize the long term growth of the market portfolio, then this portfolio exhibits a very particular dynamics. In a market without jumps the resulting dynamics equals that of the growth optimal portfolio (GOP). Conditions are formulated under which the well-known capital asset pricing model is generalized for markets with intensity based jumps. Furthermore, the Markowitz efficient frontier and the Sharpe ratio are recovered in this continuous time setting. In this paper the numeraire for derivative pricing is chosen to be the GOP. Primary security account prices, when expressed in units of the GOP, turn out to be supermartingales. In the proposed framework an equivalent risk neutral martingale measure need not exist. Fair derivative prices are obtained as conditional expectations of future payoff structures under the real world probability measure. The concept of fair pricing is shown to generalize the classical risk neutral and the actuarial net present value pricing methodologies.
    Keywords: benchmark model; jump diffusions; growth optimal portfolio; market portfolio; effiient frontier; Sharpe ratio; fair pricing; actuarial pricing
    JEL: G10 G13
    Date: 2004–12–01

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.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.