New Economics Papers
on Financial Markets
Issue of 2008‒06‒13
seven papers chosen by

  1. Hedge Fund Contagion and Liquidity By Nicole M. Boyson; Christof W. Stahel; Rene M. Stulz
  2. Model Averaging in Risk Management with an Application to Futures Markets By Pesaran, M.H.; Schleicher, C.; Zaffaroni, P.
  3. Momentum and Contrarian Stock-Market Indices By Jon Eggins; Robert J. Hill
  4. Private Equity and Regulatory Capital By Bongaerts, D.; Charlier, E.
  5. Asymptotic Maturity Behavior of the Term Structure By Klaas Schulze
  6. Real Exchange Rate Behavior: New Evidence with Linear and Non-linear Endogenous Break(s) By Chan, Tze-Haw; Chong, Lee Lee; Khong, Wye Leong Roy
  7. Exchange Rate Volatility and Exports: New Empirical Evidence from the Emerging East Asian Economies By Chit, Myint Moe; Rizov, Marian; Willenbockel, Dirk

  1. By: Nicole M. Boyson; Christof W. Stahel; Rene M. Stulz
    Abstract: Using hedge fund indices representing eight different styles, we find strong evidence of contagion within the hedge fund sector: controlling for a number of risk factors, the average probability that a hedge fund style index has extreme poor performance (lower 10% tail) increases from 2% to 21% as the number of other hedge fund style indices with extreme poor performance increases from zero to seven. We investigate how changes in funding and asset liquidity intensify this contagion, and find that the likelihood of contagion is high when prime brokerage firms have poor performance (which would be expected to affect hedge fund funding liquidity adversely) and when stock market liquidity (a proxy for asset liquidity) is low. Finally, we examine whether extreme poor performance in the stock, bond, and currency markets is more likely when contagion in the hedge fund sector is high. We find no evidence that contagion in the hedge fund sector is associated with extreme poor performance in the stock and bond markets, but find significant evidence that performance in the currency market is worse when hedge fund contagion is high, consistent with the effects of an unwinding of carry trades.
    JEL: G11 G12 G18 G23
    Date: 2008–06
  2. By: Pesaran, M.H.; Schleicher, C.; Zaffaroni, P.
    Abstract: This paper considers the problem of model uncertainty in the case of multi-asset volatility models and discusses the use of model averaging techniques as a way of dealing with the risk of inadvertently using false models in portfolio management. Evaluation of volatility models is then considered and a simple Value-at-Risk (VaR) diagnostic test is proposed for individual as well as `average' models. The asymptotic as well as the exact ¯nite-sample distribution of the test statistic, dealing with the possibility of parameter uncertainty, are established. The model averaging idea and the VaR diagnostic tests are illustrated by an application to portfolios of daily returns on six currencies, four equity indices, four ten year government bonds and four commodities over the period 1991-2007. The empirical evidence supports the use of `thick' model averaging strategies over single models or Bayesian type model averaging procedures.
    Keywords: Model Averaging, Value-at-Risk, Decision Based Evaluations.
    JEL: C32 C52 C53 G11
    Date: 2008–01
  3. By: Jon Eggins (Russell Investment Group); Robert J. Hill (School of Economics, University of New South Wales)
    Abstract: We propose a new class of investable momentum and contrarian stock-market indices that partition a benchmark index, such as the Russell 1000. Our momentum indices overweight stocks that have recently outperformed, while our contrarian indices underweight these same stocks. Our index construction methodology is extremely flexible, and allows the index provider to trade-off the distinctiveness of the momentum/contrarian strategies with portfolio turnover. Momentum investment styles in particular typically entail a high level of turnover, and hence high associated transaction costs. The creation of momentum and contrarian indices and exchange traded funds (ETFs) based on our methodology would allow investors to access these styles at lower cost than is currently possible. Our indices also provide performance benchmarks for momentum/contrarian investment managers, and good proxies for a momentum factor. Over the period 1995- 2007 we find that short term momentum and long term contrarian indices outperform the reference Russell 1000 index. We also document the changing interaction between the momentum/contrarian and value/growth styles.
    Keywords: Momentum index; Contrarian index; Performance measurement; Turnover; Momentum factor; Behavioral finance
    JEL: C43 G11 G23
    Date: 2008–05
  4. By: Bongaerts, D.; Charlier, E. (Tilburg University, Center for Economic Research)
    Abstract: Regulatory Capital requirements for European banks have been put forward in the Basel II Capital Framework and subsequently in the Capital Requirements Directive (CRD) of the EU. We provide a detailed discussion of the capital requirements for private equity investments under the simple risk weight approach, the PD/LGD approach and the internal model approach. For the latter we present a structural model for which we calibrate the parameters from a proprietary dataset. We modify the standard Merton structural model to make it applicable in practice and to capture stylized facts of these investments. We also show how to implement the early default features of our model in a simulation algorithm with very low computational costs. Our results support capital requirements lower than in Basel II, but not as low as in CRD. A sensitivity analysis shows that this finding is robust to parameter uncertainty and stress scenarios. This is likely to give adverse incentives to banks for using advanced risk models.
    Keywords: Private Equity;Regulatory Capital;Risk Management
    JEL: G21 G28 G32
    Date: 2008
  5. By: Klaas Schulze
    Abstract: Pricing and hedging of long-term interest rate sensitive products require to extrapolate the term structure beyond observable maturities. For the resulting limiting term structure we show two results by postulating no arbitrage in a bond market with infinitely increasing maturities: long zero-bond yields and long forward rates (i) are monotonically increasing and (ii) equal their minimal future value. Both results constrain the asymptotic maturity behavior of stochastic yield curves. They are fairly general and extend beyond semimartingale modeling. Hence our framework embeds arbitrage-free term structure models and imposes restrictions on their specification.
    Keywords: bond markets, yield curve, long forward rates, no arbitrage, asymptotic maturity
    JEL: G10 G12 E43
    Date: 2008–06
  6. By: Chan, Tze-Haw; Chong, Lee Lee; Khong, Wye Leong Roy
    Abstract: Using monthly frequency data from 1981 to 2005, we test for the potential mean reversion of Japan-US real exchange rates using newly improved unit root tests allowing for endogenous (unknown) break(s) in the linear as well as non-linear manner. Both countries have contributed vital proportion in global trading on top of being the major trading partner to each other since 1960s. We identify structural breaks in 1985 and 1994 respectively via the Lumsdaine and Papell (1997)’s linear test, but the results were against the PPP hypothesis. The Saikkonen and LÄutkepohl, (2002)’s test, however, provides sufficient supports for non-linear adjustment of real exchange towards long run PPP. In addition, stronger evidence for PPP is found in the post-1994 period, in conjunction with the small persistence of real exchange deviations (half-life less than a year). Also, the exchange rate misalignment is less evident after the Plaza Accord 1985. In brief, our findings reveal that the Japanese authority has shown some form of PPP-oriented rule as a basis for their exchange rate policies, in the presence of structural break(s) and non-linearity.
    Keywords: Real Exchange Rates; Endogenous Breaks; Non-linearity; Half-life
    JEL: C52 C12 N15 F31
    Date: 2008–04–28
  7. By: Chit, Myint Moe; Rizov, Marian; Willenbockel, Dirk
    Abstract: This paper examines the impact of bilateral real exchange rate volatility on real exports of five emerging East Asian countries among themselves as well as to thirteen industrialised countries. We explicitly recognize the specificity of the exports between the emerging East Asian and industrialised countries and employ a generalized gravity model that combines a traditional long-run export demand model with gravity type variables. In the empirical analysis we use a panel comprising 25 years of quarterly data and perform unit-root and cointegration tests to verify the long-run relationship among the regression variables. The results provide strong evidence that exchange rate volatility has a negative impact on the exports of emerging East Asian countries. These results are robust across different estimation techniques and do not depend on the variable chosen to proxy exchange rate uncertainty.
    Keywords: Trade; uncertainty; exchange rate fluctuations; East Asia;
    JEL: O53 O24 F14 F31
    Date: 2008–03

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