nep-fmk New Economics Papers
on Financial Markets
Issue of 2008‒01‒05
eight papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. The microstructure of the U.S. treasury market By Bruce Mizrach; Christopher J. Neely
  2. "The Natural Instability of Financial Markets" By Jan Kregel
  3. Strengths and Weaknesses in Securities Market Regulation: A Global Analysis By Jennifer A. Elliott; Ana Carvajal
  4. Are there Structural Breaks in Realized Volatility? By Chun Liu; John M Maheu
  5. Financial Literacy and Stock Market Participation By Maarten van Rooij; Annamaria Lusardi; Rob Alessie
  6. Subprime mortgage delinquency rates By Mark Doms; Fred Furlong; John Krainer
  7. Liquidity Risk and Correlation Risk: A Clinical Study of the General Motors and Ford Downgrade of May 2005 By Acharya, Viral V; Schaefer, Stephen M; Zhang, Yili
  8. Regulation versus Competition on European Financial Markets By Horobet , Alexandra; Ilie, Livia

  1. By: Bruce Mizrach; Christopher J. Neely
    Abstract: This article discusses the microstructure of the U.S. Treasury securities market. Treasury securities are nominally riskless debt instruments issued by the U.S. government. Microstructural analysis is a field of economics/finance that examines the roles played by heterogenous agents, institutional detail, and asymmetric information in the trading process. The article describes types of Treasury issues; stages of the Treasury market; the major players, including the role of the Federal Reserve Bank of New York and the interdealer brokers; the structure of both the spot and futures markets; the findings of the seasonality/announcement and order book literature; and research on price discovery. We conclude by discussing possible future avenues of research.
    Keywords: Government securities
    Date: 2007
  2. By: Jan Kregel
    Abstract: This paper contrasts the economic incentives implicit in the Keynes-Minsky approach to inherent financial market instability with the incentives behind the traditional equilibrium approach leading to market stability to provide a framework for analyzing the stability induced by the recent changes in bank regulation to modernize financial services and the evolution of financial engineering innovations in the U.S. financial system. It suggests that the changes that have occurred in the profit incentives for bank holding companies have modified the provision of liquidity to the financial system by banks, and the way credit assessment has moved from banks to other actors in the system. It takes the current experience in financial instability created by the expansion, through securitization, of the mortgage market as an example of these changes.
    Date: 2007–12
  3. By: Jennifer A. Elliott; Ana Carvajal
    Abstract: This paper examines the strengths and weaknesses of securities regulatory systems worldwide with a view to a better understanding of common problems and areas of global concern. We found that a consistent theme emerges regarding the lack of ability of regulators to effectively enforce compliance with existing rules and regulation. In many countries, a combination of factors, including insufficient legal authority, a lack of resources, political will and skills, has undermined the regulator's capacity to effectively execute regulation. This weakness is more acute in areas of increased technical complexity such as standards for and supervision of the valuation of assets and risk management practices.
    Keywords: Securities markets , Securities regulations ,
    Date: 2007–11–09
  4. By: Chun Liu; John M Maheu
    Abstract: Constructed from high-frequency data, realized volatility (RV) provides an efficient estimate of the unobserved volatility of financial markets. This paper uses a Bayesian approach to investigate the evidence for structural breaks in reduced form time-series models of RV. We focus on the popular heterogeneous autoregressive (HAR) models of the logarithm of realized volatility. Using Monte Carlo simulations we demonstrate that our estimation approach is effective in identifying and dating structural breaks. Applied to daily S&P 500 data from 1993-2004, we find strong evidence of a structural break in early 1997. The main effect of the break is a reduction in the variance of log-volatility. The evidence of a break is robust to different models including a GARCH specification for the conditional variance of log(RV).
    Keywords: realized volatility, change point, marginal likelihood, Gibbs sampling, GARCH
    JEL: C22 C11 G10
    Date: 2007–12–18
  5. By: Maarten van Rooij (De Nederlandsche Bank); Annamaria Lusardi (Dartmouth College); Rob Alessie (Utrecht University)
    Abstract: Individuals are increasingly put in charge of their financial security after retirement. Moreover, the supply of complex financial products has increased considerably over the years. However, we still have little or no information about whether individuals have the financial knowledge and skills to navigate this new financial environment. To better understand financial literacy and its relation to financial decision-making, we have devised two special modules for the DNB Household Survey. We have designed questions to measure numeracy and basic knowledge related to the working of inflation and interest rates, as well as questions to measure more advanced financial knowledge related to financial market instruments (stocks, bonds, and mutual funds). We evaluate the importance of financial literacy by studying its relation to the stock market: Are more financially knowledgeable individuals more likely to hold stocks? To assess the direction of causality, we make use of questions measuring financial knowledge before investing in the stock market. We find that, while the understanding of basic economic concepts related to inflation and interest rate compounding is far from perfect, it outperforms the limited knowledge of stocks and bonds, the concept of risk diversification, and the working of financial markets. We also find that the measurement of financial literacy is very sensitive to the wording of survey questions. This provides additional evidence for limited financial knowledge. Finally, we report evidence of an independent effect of financial literacy on stock market participation: Those who have low financial literacy are significantly less likely to invest in stocks.
    Keywords: Portfolio choice; Knowledge of Economics and Finance, Financial Sophistication
    JEL: D91 G11 D80
    Date: 2007–10
  6. By: Mark Doms; Fred Furlong; John Krainer
    Abstract: We evaluate the importance of three different channels for explaining the recent performance of subprime mortgages. First, the riskiness of the subprime borrowing pool may have increased. Second, pockets of regional economic weakness may have helped push a larger proportion of subprime borrowers into delinquency. Third, for a variety of reasons, the recent history of local house price appreciation and the degree of house price deceleration may have affected delinquency rates on subprime mortgages. While we find a role for all three candidate explanations, patterns in recent house price appreciation are far and away the best single predictor of delinquency levels and changes in delinquencies. Importantly, after controlling for the current level of house price appreciation, measures of house price deceleration remain significant predictors of changes in subprime delinquencies. The results point to a possible role for changes in house price expectations for explaining changes in delinquencies.
    Keywords: Mortgage loans ; Housing - Prices
    Date: 2007
  7. By: Acharya, Viral V; Schaefer, Stephen M; Zhang, Yili
    Abstract: The GM and Ford downgrade to junk status during May 2005 caused a wide-spread sell-off in their corporate bonds. Using a novel dataset, we document that this sell-off appears to have generated significant liquidity risk for market-makers, as evidenced in the significant imbalance in their quotes towards sales. We also document that simultaneously, there was excess co-movement in the fixed-income securities of all industries, not just in those of auto firms. In particular, using credit-default swaps (CDS) data, we find a substantial increase in the co-movement between innovations in the CDS spreads of GM and Ford and those of firms in all other industries, the increase being greatest during the period surrounding the actual downgrade and reversing sharply thereafter. We show that a measure of liquidity risk faced by corporate bond market-makers – specifically, the imbalance towards sales in the volume and frequency of quotes on GM and Ford bonds – explains a significant portion of this excess co-movement. Additional robustness checks suggest that this relationship between the liquidity risk faced by market-makers and the correlation risk for other securities in which they make markets was likely causal. Overall, the evidence is supportive of theoretical models which imply that funding liquidity risk faced by financial intermediaries is a determinant of market prices during stress times.
    Keywords: excess co-movement; financial crises; funding liquidity; inventory risk; market liquidity
    JEL: G12 G13 G14 G21 G22
    Date: 2007–12
  8. By: Horobet , Alexandra; Ilie, Livia
    Abstract: Competition is the mechanism that helps companies, institutions and markets to become more productive and efficient. one of the main obstacles to economic growth is represented by the policies that hinder competition. Excessive protection may create a handicap for the European economic system which will have not all the necessary instruments to face the increasing competition between companies, countries, economic regions.The paper aims at analyzing the relationship between regulation, competition and economic performances applied to European capital markets, as opposed to US capital markets.
    Keywords: regulation; competition; capital market; integration
    JEL: G1 D0
    Date: 2007–12–19

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