New Economics Papers
on Financial Markets
Issue of 2008‒03‒25
four papers chosen by

  1. Stock Market Volatility and Learning By Albert Marcet; Klaus Adam; Juan Pablo Nicolini
  2. The Hedge Fund Game By Peyton Young; Dean P Foster
  3. Monetary Policy Regimes and the Volatility of Long-Term Interest Rates By Queijo von Heideken, Virginia
  4. Analysis into IPO underpricing and clustering in Hong Kong equity market By Qiao, Yongyuan

  1. By: Albert Marcet; Klaus Adam; Juan Pablo Nicolini
    Abstract: Introducing bounded rationality in a standard consumption-based asset pricing model with time separable preferences strongly improves empirical performance. Learning causes momentum and mean reversion of returns and thereby excess volatility, persistence of price-dividend ratios, long-horizon return predictability and a risk premium, as in the habit model of Campbell and Cochrane (1999), but for lower risk aversion. This is obtained, even though our learning scheme introduces just one free parameter and we only consider learning schemes that imply small deviations from full rationality. The findings are robust to the learning rule used and other model features. What is key is that agents forecast future stock prices using past information on prices.
    JEL: G12 D84
    Date: 2008–01–25
  2. By: Peyton Young (Dept of Economics, University of Oxford); Dean P Foster (Dept of Statistics, Wharton School)
    Abstract: This paper examines theoretical properties of incentive contracts in the hedge fund industry. We show that it is very difficult to structure incentive payments that distinguish between unskilled managers, who cannot generate excess market returns, and skilled managers who can deliver such returns. Under any incentive scheme that does not levy penalties for underperformance, managers with no investment skill can game the system so as to earn (in expectation) the same amount per dollar of funds under management as the most skilled managers. We consider various ways of eliminating this “piggy-back effect,” such as forcing the manager to hold an equity stake or levying penalties for underperformance. The nature of the derivatives market means that none of these remedies can correct the problem entirely.
    Keywords: incentive contracts, excess returns
    Date: 2008–03–18
  3. By: Queijo von Heideken, Virginia (Research Department, Central Bank of Sweden)
    Abstract: This paper addresses two important questions that have, so far, been studied separately in the literature. First, the paper aims at explaining the high volatility of long-term interest rates observed in the data, which is hard to replicate using standard macro models. Building a small-scale macroeconomic model and estimating it on U.S. and U.K. data, I show that the policy responses of a central bank that is uncertain about the natural rate of unemployment can explain this volatility puzzle. Second, the paper aims at shedding new light on the distinction between rules and discretion in monetary policy. My empirical results show that using yield curve data may facilitate the empirical discrimination between different monetary policy regimes and that U.S. monetary policy is best understood as originating from a discretionary regime since 1960.
    Keywords: long-term interest rates; optimal monetary policy; discretion; commitment; Bayesian estimation
    JEL: C11 C13 C15 E32 E42 E43 E47 E50
    Date: 2008–02–01
  4. By: Qiao, Yongyuan
    Abstract: This paper focuses on the time series properties of the level of underpricing of IPO shares and volume of initial selling in Hong Kong equity market. Strong autocorrelation among the level of underpricing has been identified. Evidence suggests that the initial selling volume plays an important role in the relationship. The links between underpricing and clustering of IPOs within different industries are weak, suggesting the reasons for underpricing are rather related to the market liquidity than industry specific risk characteristics.
    Keywords: Underpricing of IPO shares; Hong Kong equity market; the volume of initial selling; Market liquidity.
    JEL: G14 G11 G32 G24
    Date: 2008–02–20

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