New Economics Papers
on Financial Markets
Issue of 2007‒04‒09
ten papers chosen by

  1. Emerging Stock Market Returns: The CAPM Challenge. By Laurent Gheeraert
  2. A No-Arbitrage Analysis of Macroeconomic Determinants of Term Structures and the Exchange Rate<br> By Fousseni Chabi-Yo; Jun Yang
  3. Corporate Balance Sheets in Developed Economies: Implications for Investment By Denise Côté; Christopher Graham
  4. The Determinants of Corporate Risk in Emerging Markets: An Option-Adjusted Spread Analysis By Eduardo A. Cavallo
  5. Anatomy of Bid-Ask Spread Empirical Evidence from an Order-driven Market By Ming-Chang Wang; Lon-Ping Zu; Chau-Jung Kuo
  6. Bond Immunization and Exchange Rate Risk: Some Further Considerations By Ivan Ivanov; Jason Hecht
  7. The Asymmetry of the Price Impact of Block Trades and the Bid-Ask Spread. Evidence from the London Stock Exchange By Andros Gregoriou
  8. Underpricing in Turkey: Comparison of the IPO Methods By Guray Kucukkocaoglu
  9. Uncovering Yield Parity: A New Insight into the UIP Puzzle through the Stationarity of Long Maturity Forward Rates By Zsolt Darvas; Gábor Rappai; Zoltán Schepp
  10. Who Leads Financial Markets? By Enzo Weber

  1. By: Laurent Gheeraert (Centre Emile Bernheim, Solvay Business School, Université Libre de Bruxelles, Brussels.)
    Abstract: With a double-digit growth rate in total market capitalization over the last decade, emerging stocks are becoming an increasingly important investment category. Emerging market equities behave in a different way from equities traded on developed capital markets. In the literature, there is usually a consensus on at least four distinguishing features of emerging market stock returns: (1) volatility is high, (2) correlations with developed market returns are low, (3) returns are predictable to a certain extent, (4) third and fourth moments matter. However, opinions differ about average attractiveness of realized returns in emerging markets, depending on the period studied, the region, and the methodologies. This paper surveys the wide literature around marginal and expected moments of the distribution of emerging stock returns. It reviews literature findings in a structure per statistical moment. Then, it examines the potential consequences on the applicability of the CAPM in emerging markets. Finally,it exposes avenues for further research identified from the survey.
    Keywords: emerging stock markets, equity returns, investment, moments.
    JEL: G15 G11 F30
    Date: 2006–09
  2. By: Fousseni Chabi-Yo; Jun Yang
    Abstract: We study the joint dynamics of macroeconomic variables, bond yields, and the exchange rate in an empirical two-country New-Keynesian model complemented with a no-arbitrage term structure model. With Canadian and US data, we are able to study the impact of macroeconomic shocks from both countries on their yield curves and the exchange rate. The variance decomposition of the yield level shows that the US monetary policy and aggregate supply shocks explain a majority of the unconditional variations in Canadian yields. They also explain up to 50% of the variations in the expected excess holding period returns of Canadian bonds. In addition, Canadian monetary policy shocks explain more than 70% of the variations in Canadian yields over short and medium forecast horizons. It also explains around 40% of the expected excess holding period returns of Canadian bonds. Both Canadian and US macroeconomic shocks help explain the dynamics of the exchange rate and the time-varying exchange risk premium.
    Keywords: Debt management; Exchange rates; Interest rates; Financial markets; Econometric and statistical methods
    JEL: E12 E43 F41 G12 G15
    Date: 2007
  3. By: Denise Côté; Christopher Graham
    Abstract: In this paper, the authors examine the aggregate national balance-sheets of non-financial corporations in Australia and the G7 countries with a view to assessing both their financial structure and their financial position. More importantly, the authors investigate whether the financial position of non-financial corporations (i.e., debt-to-equity ratio) is material to the economy's investment prospects and whether the importance of this channel differs depending on the structure of corporate financing i.e., bank-based or market-oriented financing structures. Based on a dynamic business investment error-correction model that controls for the opportunity cost of capital and output growth, the authors test the above hypotheses using a quarterly panel dataset of eight developed economies over the 1992-2005 period. Their empirical results suggest that the financial position of non-financial corporations has a statistically significant impact on aggregate business investment growth, although the effect is quantitatively modest. Thus, their findings are consistent with the prediction of models that feature credit market imperfections such as costly information and asymmetric information. Moreover, the effect of corporate financial position appears to be statistically equivalent regardless of whether a country's corporations predominantly finance their investments through bank borrowing or market-oriented financing.
    Keywords: Business fluctuations and cycles; International topics
    JEL: E22 E32 E44
    Date: 2007
  4. By: Eduardo A. Cavallo (Inter-American Development Bank)
    Abstract: This study explores the determinants of corporate bond spreads in emerging markets economies. Using a largely unexploited dataset, the paper finds that corporate bond spreads are determined by firm-specific variables, bond characteristics, macroeconomic conditions, sovereign risk, and global factors. A variance decomposition analysis shows that firm-level characteristics account for the larger share of the variance. In addition, the paper finds two asymmetries. The first is in line the sovereign ceiling “lite” hypothesis which states that the transfer of risk from the sovereign to the private sector is less than 1 to 1. The second is consistent with the popular notion that panics are common in emerging markets where investors are less informed and more prone to herding.
    Keywords: Corporate Bond Spreads, Sovereign Ceiling, Default Risk, Emerging Market
    JEL: E43 F30 F34 G15
    Date: 2007–04
  5. By: Ming-Chang Wang (Department of Finance and Banking, Cheng Shiu University); Lon-Ping Zu (Department of Finance and Banking, Shih Chien University); Chau-Jung Kuo (Department of Finance, National Sun Yat-Sen University)
    Abstract: Under fairly basic rationales, this paper provides a more general microstructure model of price quotation in an order driven market. Specifically, as an extension of Handa and Schwartz (1996), we decompose the equilibrium of the bid-ask spread, which is derived as a function of the weighted average of three factors including the different valuation of traders and the expected loss of adverse selection respectively from buyers and sellers, into the implicate components which evolve from the characteristics of traders and market competition. More importantly, we can distinguish the expected loss of adverse selection, which is endogenously formed in our model, between from buyers and from sellers and investigate the key determinants of the expected loss of adverse selection. The numerical tests clearly show the relationships between the spread and all exogenous parameters. Furthermore, the empirical tests using transaction data on all listed shares in TAIEX provide strong support for our model and show that the asset volatility and the probability of informed trading are significantly positively related to the adverse selection costs. Our results indicate that on average the different valuations account for approximately 26.02% of the bid-ask spread, seller’s expected loss of adverse selection account for 36.95% , and buyer’s one account for 37.03%.
    Keywords: Market Microstructure, Order Strategy, Bid-Ask Spread, Adverse Selection Cost, Price Formation, Order Driven Market,
    Date: 2007–02–02
  6. By: Ivan Ivanov (Ramapo College of New Jersey); Jason Hecht (Ramapo College of New Jersey)
    Abstract: This research project seeks to address two critical problems in the theory of international bond pricing: 1) how can exchange rate risk be formally incorporated into standard bond valuation models?, and 2) how must strategies to “immunize†bonds against interest rate and inflation risk be modified to also incorporate exchange rate risk? Most of all, this study analyzes the mathematical properties of international bonds (e.g., Eurobonds). A special consideration is given to the two most important characteristics of debt securities – duration and convexity and through them to the various ways to immunize bonds and bond portfolios from real interest, inflation, and exchange rate risks. Fogler (1984) formally addressed the effects of changes in inflation and interest rates on bond prices. Unfortunately, exchange rate risk does not appear to have been formally incorporated into these previous models. Moreover, we correct a mathematical error in Fogler’s analysis.
    Keywords: bond immunization
    JEL: F31 G11 H63
    Date: 2007–02–02
  7. By: Andros Gregoriou (Brunel Business School, Economics and Finance Section, Brunel University)
    Abstract: In this paper we examine the price impact of block trades for FTSE 100 firms over the time period 1998-2004. Resembling previous research we find evidence of an asymmetric price impact between block purchases and sales. We suggest that bid-ask bias may be a new conjecture to the asymmetry in the differences in buyer and seller initiated trades.
    Keywords: Block Trades, Bid-Ask Bias, Asymmetry, Market Microstructure
    JEL: G14
    Date: 2007–02–02
  8. By: Guray Kucukkocaoglu (Baskent University)
    Abstract: This paper addresses the question of what kind of selling and underwriting procedure might be preferred for controlling the amount and volatility of underpricing in the Istanbul Stock Exchange (ISE). Using 1993-2005 firm and issue data, we compare the three substantially different IPO methods available in the ISE. One is very similar to the book building mechanism used in the U.S., another is the fixed price offer, and the third one is the sale through the stock exchange method. The empirical analysis reveals significant first day underpricing of 7.01% in fixed price offer, 11.47% in book building mechanism, and 15.68% in sale through the stock exchange method. Finally, we also show that fixed price offers can better control the impact of market information on underpricing than sale through the stock exchange method
    Keywords: ipo, book building, fixed price offer, istanbul stock exchange, emerging market
    JEL: G15
    Date: 2007–02–02
  9. By: Zsolt Darvas (Corvinus University Budapest); Gábor Rappai (University of Pécs); Zoltán Schepp (University of Pécs)
    Abstract: Results and models of this paper are based on a strikingly new empirical observation: long maturity forward rates between bilateral currency pairs of the US, Germany, UK, and Switzerland are stationary. Based on this result, we suggest a new explanation for the UIP-puzzle maintaining rational expectations and risk neutrality. The model builds on the interaction of foreign exchange and fixed income markets. Ex ante short run and long run UIP and the EHTS is assumed. We show that ex post shocks to the term structure could explain the behavior of the nominal exchange rate including its volatility and the failure of ex post short UIP regressions. We present evidence on ex post validity of long run UIP and strikingly new evidence on the stationarity of the long forward exchange rates of major currencies. We set up, calibrate and simulate a stylized model that well captures the observed properties of spot exchange rates and UIP regressions of major currencies. We define the notion of yield parity and test its empirical performance for monthly series of major currencies with favorable results
    Keywords: EHTS, forward discount bias, stationarity of long maturity forward rates, UIP, yield parity
    JEL: E43 F31
    Date: 2007–02–02
  10. By: Enzo Weber
    Abstract: The present paper embarks on an analysis of interactions between the US and Euroland in the capital, foreign exchange, money and stock markets from 1994 until 2006. Considering influences on financial market volatility, the estimations are carried out in multivariate EGARCH models using structural residuals. This approach consequently allows identifying the contemporaneous effects between the daily variables. Structural VARs or VECMs can therefore give answers to the question of financial markets leadership: Generally speaking, the US effects on Europe still dominate, but the special econometric methodology is able to uncover otherwise neglected effects in the reverse direction.
    Keywords: Structural EGARCH, Financial Markets, United States, Euro Zone.
    JEL: C32 G15
    Date: 2007–04

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.