nep-fmk New Economics Papers
on Financial Markets
Issue of 2007‒05‒26
four papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Estimation risk effects on backtesting for parametric value-at-risk models By J. Carlos Escanciano; Jose Olmo
  2. Credit Constraints and Stock Price Volatility By Hale, Galina B; Razin, Assaf; Tong, Hui
  3. Cointegration and Consumption Risks in Asset Returns By Ravi Bansal; Robert Dittmar; Dana Kiku
  4. Random Walk Tests for the Lisbon Stock Market By Maria Rosa Borges

  1. By: J. Carlos Escanciano (Indiana University, Bloomington, IN, USA); Jose Olmo (Department of Economics, City University, London)
    Abstract: One of the implications of the creation of Basel Committee on Banking Supervision was the implementation of Value-at-Risk (VaR) as the standard tool for measuring market risk. Thereby the correct specification of parametric VaR models became of crucial importance in order to provide accurate and reliable risk measures. If the underlying risk model is not correctly specified, VaR estimates understate/overstate risk exposure. This can have dramatic consequences on stability and reputation of financial institutions or lead to sub-optimal capital allocation. We show that the use of the standard unconditional backtesting procedures to assess VaR models is completely misleading. These tests do not consider the impact of estimation risk and therefore use wrong critical values to assess market risk. The purpose of this paper is to quantify such estimation risk in a very general class of dynamic parametric VaR models and to correct standard backtesting procedures to provide valid inference in specification analyses. A Monte Carlo study illustrates our theoretical findings in finite-samples. Finally, an application to S&P500 Index shows the importance of this correction and its impact on capital requirements as imposed by Basel Accord, and on the choice of dynamic parametric models for risk management.
    Keywords: Backtesting, Basel Accord, Model Risk, Risk management,Value at Risk, Conditional Quantile
    Date: 2007–05
    URL: http://d.repec.org/n?u=RePEc:cty:dpaper:07/11&r=fmk
  2. By: Hale, Galina B; Razin, Assaf; Tong, Hui
    Abstract: This paper addresses how creditor protection affects the volatility of stock market prices. Credit protection reduces the probability of oscillations between binding and non-binding states of the credit constraint; thereby lowering the rate of return variance. We test this prediction of a Tobin’s q model, by using cross-country panel regression on stock price volatility in 40 countries over the period from 1984 to 2004. Estimated probabilities of a liquidity crisis are used as a proxy for the probability that credit constraints are binding. We find support for the hypothesis that institutions that help reduce the probability of oscillations between binding and non-binding states of the credit constraint also reduce asset price volatility.
    Keywords: binding credit constraints; liquidity crises; Tobin-q investment model
    JEL: E4 F3 G0
    Date: 2007–05
    URL: http://d.repec.org/n?u=RePEc:cpr:ceprdp:6310&r=fmk
  3. By: Ravi Bansal; Robert Dittmar; Dana Kiku
    Abstract: We argue that the cointegrating relation between dividends and consumption, a measure of long run consumption risks, is a key determinant of risk premia at all investment horizons. As the investment horizon increases, transitory risks disappear, and the asset's beta is dominated by long run consumption risks. We show that the return betas, derived from the cointegration-based VAR (EC-VAR) model, successfully account for the crosssectional variation in equity returns at both short and long horizons; this is not the case when the cointegrating restriction is ignored. Our evidence highlights the importance of cointegration-based long run consumption risks for financial markets.
    JEL: C01 C13 G00 G1 G12
    Date: 2007–05
    URL: http://d.repec.org/n?u=RePEc:nbr:nberwo:13108&r=fmk
  4. By: Maria Rosa Borges
    Abstract: This paper reports the results of tests on the weak-form market efficiency applied to the PSI-20 index prices of the Lisbon Stock Market from January 1993 to December 2006. As an emerging stock market, it is unlikely that it is fully information-efficient, but we show that the level of weak-form efficiency has increased in recent years. We use a serial correlation test, a runs test, an augmented Dickey-Fuller test and the multiple variance ratio test proposed by Lo and MacKinlay (1988) for the hypothesis that the stock market index follows a random walk. Non-trading or infrequent trading is not an issue because the PSI-20 only includes the 20 most traded shares. The tests are performed using daily, weekly and monthly returns for the whole period and for five sub-periods which reflect different trends in the market. We find mixed evidence, but on the whole, our results show that the Portuguese stock market index has been approaching a random walk behavior since year 2000, with a decrease in the serial dependence of returns.
    JEL: G14 G15
    Date: 2007
    URL: http://d.repec.org/n?u=RePEc:ise:isegwp:wp142007&r=fmk

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