nep-fmk New Economics Papers
on Financial Markets
Issue of 2008‒05‒17
thirteen papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Non-linear predictability in stock and bond returns: when and where is it exploitable? By Massimo Guidolin; Stuart Hyde; David McMillan; Sadayuki Ono
  2. Trouble Ahead – The Subprime Crisis as Evidence of a New Regime in the Stock Market By Tanya Araújo; Francisco Louçã
  3. Asymmetric Volatility Spillovers between Stock Market and Real Activity: Evidence from UK and US By Nikolaos Giannellis; Athanasios Papadopoulos
  4. Volatility Forecasting Using Explanatory Variables and Focused Selection Criteria By Christian T. Brownlees; Giampiero Gallo
  5. Tribes under Threat – The Collective Behavior of Firms During the Stock Market Crisis By Tanya Araújo; Francisco Louçã
  6. Constrained Smoothing Splines for the Term Structure of Interest Rates By Laurini, Márcio P.; Moura, Marcelo
  7. Financial Systems, Micro-Systemic Risks and Central Bank Policy : An Analytical Taxonomy of the Literature By Moheeput, Ashwin
  8. Risk Transfer with CDOs By Jan Pieter Krahnen; Christian Wilde
  9. Comparison of Volatility Measures: a Risk Management Perspective By Christian T. Brownlees; Giampiero Gallo
  10. Empirical Market Microstructure: An Analysis Of The Brl/Us$ Exchange Rate Market Using High-Frequency Data By Laurini, Márcio P. & Furlani, Luiz G. C. & Portugual, Marcelo S.
  11. Do Futures Benefit Farmers? By Lence, Sergio H.
  12. The signalling hypothesis revisited: Evidence from foreign IPOs By Francis , Bill B; Hasan , Iftekhar; Lothian , James R; Sun, Xian
  13. Measuring and Analyzing the Liquidity of the Italian Treasury Security Wholesale Secondary Market By Coluzzi, Chiara; Ginebri, Sergio; Turco, Manuel

  1. By: Massimo Guidolin; Stuart Hyde; David McMillan; Sadayuki Ono
    Abstract: We systematically examine the comparative predictive performance of a number of alternative linear and non-linear models for stock and bond returns in the G7 countries. Besides Markov switching, threshold autoregressive (TAR), and smooth transition autoregressive (STAR) regime switching (predictive) regression models, we also estimate univariate models in which conditional heteroskedasticity is captured through GARCH, TARCH and EGARCH models and ARCH-in mean effects appear in the conditional mean. Although we fail to find a consistent winner/out-performer across all countries and asset markets, it turns out that capturing non-linear effects is of extreme importance to improve forecasting performance. U.S. and U.K. asset return data are "special" in the sense that good predictive performance seems to loudly ask for models that capture non linear dynamics, especially of the Markov switching type. Although occasionally also stock and bond return forecasts for other G7 countries appear to benefit from non-linear modeling (especially of TAR and STAR type), data from France, Germany, and Italy express interesting predictive results on the basis of simpler benchmarks. U.S. and U.K. data are also the only two data sets in which we find statistically significant differences between forecasting models. Results appear to be remarkably stable over time, and robust to the specification of the loss function used in statistical evaluations as well as to the methodology employed to perform pairwise comparisons.
    Keywords: Group of Seven countries ; Financial markets
    Date: 2008
  2. By: Tanya Araújo; Francisco Louçã
    Date: 2008–04
  3. By: Nikolaos Giannellis (Department of Economics, University of Crete, Greece); Athanasios Papadopoulos (Department of Economics, University of Crete, Greece)
    Abstract: By estimating bivariate EGARCH (2, 1) models, we find significant short run dynamic relations between stock market and real activity for the UK and the US over the period 1970-2002. There is evidence of significant reciprocal volatility spillovers between the two sectors within a country, implying stronger interdependencies in UK rather than in US. Volatility spillovers, transmitted via the balance sheet channel, are found to be asymmetric only in the case of UK. Namely, a negative shock in the stock market increases volatility in the real economy more than a positive shock.
    Keywords: Stock market, real activity, volatility spillovers, UK, US
    JEL: C32 E44 G12
    Date: 2007–02–01
  4. By: Christian T. Brownlees (Università degli Studi di Firenze, Dipartimento di Statistica); Giampiero Gallo (Università degli Studi di Firenze, Dipartimento di Statistica "G. Parenti")
    Abstract: This paper assesses the performance of volatility forecasting using focused selection and combination strategies to include relevant explanatory variables in the forecasting model. The focused selection/combination strategies consist of picking up the model that minimizes the estimated risk (e.g. MSE) of a given smooth function of the parameters of interest to the forecaster. The proposed focused methods are compared with other strategies, including the well established AIC and BIC. The methodology is applied to a daily recursive 1--step ahead value--at--risk (VaR) forecasting exercise of 4 widely traded New York Stock Exchange stocks. Results show that VaR forecasts can significantly be improved upon using focused forecast strategies for the selection of relevant exogenous information. The set of explanatory variables that helps improving prediction is stock dependent. Traditional information criteria do not appear to be helpful in suggesting the inclusion of explanatory variables that actually improve prediction significantly. In line with recent theoretical findings, the predictive performance of the BIC appears to be modest.
    Keywords: Forecasting, Shrinkage Estimation, FIC, MEM, GARCH, ACD
    JEL: C22 C51 C53
    Date: 2007–05
  5. By: Tanya Araújo; Francisco Louçã
    Abstract: Due to their unpredictable behavior, stock markets are examples of complex systems. Yet, the dominant analysis of these markets as- sumes simple stochastic variations, eventually tainted by short-lived memory. This paper proposes an alternative strategy, based on a stochastic geometry de¯ning a robust index of the structural dynamics of the markets and based on notions of topology de¯ning a new coef- ficient that identifies the structural changes occurring on the S&P500 set of stocks. The results demonstrate the consistency of the random hypothesis as applied to normal periods but they also show its in- adequacy as to the analysis of periods of turbulence, for which the emergence of collective behavior of sectoral clusters of firms is mea- sured. This behavior is identified as a meta-routine.
    Date: 2008–04
  6. By: Laurini, Márcio P.; Moura, Marcelo
    Date: 2007–10
  7. By: Moheeput, Ashwin (Department of Economics, University of Warwick)
    Abstract: This paper reviews and categorises the literature on micro-systemic risks and on optimal policies designed to mitigate these risks. Micro-systemic risks are risks to the financial system that occur when the interaction of a bank with other banks or with financial markets, can propagate an initially localised shock to the whole financial system and can prevent the latter from fulfilling its intermediation and distributional roles. The severe episodes of financial crises that have plagued economies - developed and emerging markets alike - have made more compelling, the need for policymakers such as central banks, to develop prudential tools as part of crisis prevention and crisis management policies. We review the success of these policies under different theoretical paradigms. The paper ends with a brief synopsis of financial accelerator models which stress on how imperfections in financial markets may magnify the swings and intensity of business cycles and have a more entrenched impact on the macroeconomy.
    Keywords: Microsystemic Risks ; Financial Fragility ; Financial Accelerator
    JEL: G20 G28
    Date: 2008
  8. By: Jan Pieter Krahnen; Christian Wilde
    Abstract: Modern bank management comprises both classical lending business and transfer of asset risk to capital markets through securitization. Sound knowledge of the risks involved in securitization transactions is a prerequisite for solid risk management. This paper aims to resolve a part of the opaqueness surrounding credit-risk allocation to tranches that represent claims of different seniority on a reference portfolio. In particular, this paper analyzes the allocation of credit risk to different tranches of a CDO transaction when the underlying asset returns are driven by a common macro factor and an idiosyncratic component. Junior and senior tranches are found to be nearly orthogonal, motivating a search for the where about of systematic risk in CDO transactions. We propose a metric for capturing the allocation of systematic risk to tranches. First, in contrast to a widely-held claim, we show that (extreme) tail risk in standard CDO transactions is held by all tranches. While junior tranches take on all types of systematic risk, senior tranches take on almost no non-tail risk. This is in stark contrast to an untranched bond portfolio of the same rating quality, which on average suffers substantial losses for all realizations of the macro factor. Second, given tranching, a shock to the risk of the underlying asset portfolio (e.g. a rise in asset correlation or in mean portfolio loss) has the strongest impact, in relative terms, on the exposure of senior tranche CDO-investors. Our findings can be used to explain major stylized facts observed in credit markets.
    JEL: G21 G28
    Date: 2008–04
  9. By: Christian T. Brownlees (Università degli Studi di Firenze, Dipartimento di Statistica); Giampiero Gallo (Università degli Studi di Firenze, Dipartimento di Statistica "G. Parenti")
    Abstract: In this paper we address the issue of forecasting Value–at–Risk (VaR) using different volatility measures: realized volatility, bipower realized volatility, two scales realized volatility, realized kernel as well as the daily range. We propose a dynamic model with a flexible trend specification bonded with a penalized maximum likelihood estimation strategy: the P-Spline Multiplicative Error Model. Exploiting UHFD volatility measures, VaR predictive ability is considerably improved upon relative to a baseline GARCH but not so relative to the range; there are relevant gains from modeling volatility trends and using realized kernels that are robust to dependent microstructure noise.
    Keywords: Volatility Measures, VaR Forecasting, GARCH, MEM, P-Spline.
    JEL: C22 C51 C52 C53
    Date: 2008–02
  10. By: Laurini, Márcio P. & Furlani, Luiz G. C. & Portugual, Marcelo S.
    Date: 2008–10
  11. By: Lence, Sergio H.
    Abstract: Simulations are used to analyze welfare and market- and farm-level effects of making futures available to producers of a storable commodity. Key features of the model are the explicit consideration of dynamic impacts due to inventories, and of aggregate market effects associated with futures adoption by some producers. Application to the natural rubber market shows that futures availability can lead to sizeable market- and farm-level effects. Futures availability enhances consumer welfare, reduces non-adopter welfare, and yields important welfare gains for adopters when their market share is small and welfare losses when they account for a sufficiently large market share.
    Keywords: Commodity markets, futures, natural rubber, rational expectations, storage model, welfare analysis
    JEL: C6 G1 Q1
    Date: 2008–04–19
  12. By: Francis , Bill B (Lally School of Management and Technology); Hasan , Iftekhar (Rensselaer Polytechnic Institute, USA and Bank of Finland Research); Lothian , James R (Graduate School of Business, Fordham University); Sun, Xian (Office of the Comptroller of the Currency, USA)
    Abstract: While the signalling hypothesis has played a prominent role as the economic rationale associated with the initial public offering (IPO) underpricing puzzle (Welch, 1989), the empirical evidence on it has been mixed at best (Jegadeesh, Weinstein and Welch, 1993; Michaely and Shaw, 1994). This paper revisits the issue from the vantage point of close to two decades of additional experience by examining a sample of foreign IPOs – firms from both financially integrated and segmented markets – in US markets. The evidence indicates that signalling does matter in determining IPO underpricing, especially for firms domiciled in countries with segmented markets, which as a result face higher information asymmetry and lack access to external capital markets. We find a significant positive and robust relationship between the degree of IPO underpricing and segmented-market firms’ seasoned equity offering activities. For firms from integrated markets, in contrast, the analyst-coverage-purchase hypothesis appears to matter more in explaining IPO underpricing and the aftermarket price appreciation explains these firms’ seasoned equity offering activities. The evidence, therefore, clearly supports the notion that some firms are willing to leave money on the table voluntarily to get a more favorable price at seasoned offerings when they are substantially wealth constrained, a prediction embedded in the signalling hypothesis.
    Keywords: IPO underpricing; seasoned equity offering; cross-listing; signalling hypothesis; financial market integration; market-feedback hypothesis
    JEL: G14 G15 G30 G32
    Date: 2008–05–06
  13. By: Coluzzi, Chiara; Ginebri, Sergio; Turco, Manuel
    Abstract: Although its importance, only recently the issue of liquidity in Treasury markets has received greater attention. We survey the literature about market liquidity and liquidity measures, and we put forward new measures. The aim is to provide a description of the liquidity of the Italian wholesale secondary market, which we describe thoroughly. We apply a large set of measures on a unique dataset, which gives us a complete view of the market. Even though the market provides an amount of liquidity that fits the market needs, the quality of the order book is low, and despite the presence of a large number of market makers, the degree of competition among them is not very high. Moreover, no clear and general relationship emerges between trading and order book measures. Indeed, even though trading activity is higher for on-the-run securities with respect to the off-the-run securities, there is not a sharp difference in terms of liquidity of the order book between them. In this case market regulation plays an important role. Finally, we investigate how long it takes for a new issue to become the benchmark for its segment. Our evidence shows that some modifications of the issuance policy in order to have a larger outstanding since the first auction could help securities in gaining earlier their benchmark status, especially in case of 10-year BTPs.
    Keywords: Liquidity, liquidity measures, Government securities, market microstructure, benchmark status.
    JEL: D49 G12 H63
    Date: 2008–05–11

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