New Economics Papers
on Financial Markets
Issue of 2008‒11‒18
twelve papers chosen by

  1. What broke the bubble? By Barnett, William A.
  2. The Sub-Prime Crisis and UK Monetary Policy By Christopher Martin; Costas Milas
  3. What Lessons have been learnt since the East Asian Crisis in 1997/98? CIBS, Capital Flows, and Exchange Rates By Pircher, Marion
  4. Volatility and Long Term Relations in Equity Markets: Empirical Evidence from Germany, Switzerland, and the UK By Guidi, Francesco
  5. "Realized Volatility, Covariance and Hedging Coefficient of the Nikkei-225 Futures with Micro-Market Noise" By Naoto Kunitomo; Seisho Sato
  6. Macro-finance VARs and bond risk premia: a caveat By Marco, Taboga
  7. An empirical analysis of the curvature factor of the term structure of interest rates By Modena, Matteo
  8. The Pricing of Federally Guaranteed Agricultural Loans: What Does it Indicate About Market Competition? By Koenig, Steven R.; Dodson, Charles B.
  9. Price Deviations of S&P 500 Index Options from the Black-Scholes Formula Follow a Simple Pattern By Li, Minqiang
  10. Modelling the Evolution of Credit Spreads using the Cox Process within the HUM Framework: A CDS Option Pricing Model By Carl Chiarella; Viviana Fanelli; Silvana Musti
  11. LIBOR additive model calibration to swaptions markets By Jesús P. Colino; Francisco J. Nogales; Winfried Stute
  12. The co-movements along the forward curve of natural gas futures: a structural view  By Spargoli , Fabrizio; Zagaglia, Paolo

  1. By: Barnett, William A.
    Abstract: This paper is the basis for the Guest Columnist article in the Tuesday, November 11, 2008 issue of the Kansas City Star newspaper's Business Weekly. Because of space limitations, the published newspaper column had to be shortened from the original and unfortunately did not include either of the two supporting figures. This is the unedited source article. The position taken by this opinion editorial is that the declining trend of total reserves during the recent period of financial crisis was counterproductive, and the declining level of the federal funds rate during that period was an inadequate indicator of Federal Reserve policy stance. But the recent startling surge in reserves potentially offsets the problem, although for reasons not motivated by the issues raised by this article. In fact, the reason for the surge is associated with the declining stock of Treasury bonds available to the Federal Reserve for sterilization of the effects of the new lending initiatives on bank reserves.
    Keywords: bubbles; bailouts; monetary policy; reserves; TAFs; sterilization; financial crisis.
    JEL: E32 G18 E52 E44 G28 E61
    Date: 2008–11–11
  2. By: Christopher Martin (Brunel University, Uxbridge, UK); Costas Milas (Keele University, Staffordshire, UK and The Rimini Centre for Economic Analysis, Italy)
    Abstract: The “sub-prime” crisis, which led to major turbulence in global financial markets beginning in mid-2007, has posed major challenges for monetary policymakers. We analyse the impact on monetary policy of the widening differential between policy rates and the 3-month Libor rate, the benchmark for private sector interest rates. We show that the optimal monetary policy rule should include the determinants of this differential, adding an extra layer of complexity to the problems facing policymakers. Our estimates reveal significant effects of risk and liquidity measures, suggesting the widening differential between base rates and Libor was largely driven by a sharp increase in unsecured lending risk. We calculate that the crisis increased libor by up to 60 basis points; in response base rates fell further and quicker than would otherwise have happened as policymakers sought to offset some of the contractionary effects of the sub-prime crisis.
    Keywords: optimal monetary policy; sub-prime crisis
    JEL: C51 C52 E52 E58
    Date: 2008–01
  3. By: Pircher, Marion
    Abstract: This paper discusses the movement of capital flows -Date and Date the exchange rate regimes and monetary policies of China, India, Brazil, and South Africa (CIBS). Furthermore, we compare the level of financial stability, and the composition and duration of capital flows of the countries on a policy level according -Date the ? ?third generation? crisis models?; following which the East Asian Crisis of 1997/98 linkages between the corporate and financial sec-Daters, and foreign short-term debt are given further attention. The paper concludes by comparing all four countries and analysing possible risks in CIBS financial systems.
    Keywords: international financial markets, financial stability, capital flows, exchange rates, China, India, Brazil, South Africa
    Date: 2008
  4. By: Guidi, Francesco
    Abstract: The aim of this paper is twofold. First it aims to compare several GARCH family models in order to model and forecast the conditional variance of German, Swiss, and UK stock market indexes. The main result is that all GARCH family models show evidence of asymmetric effects. Based on the “out of sample” forecasts I can say that for each market considered there is a model that will lead to better volatility forecasts. Secondly a long run relation between these markets was investigated using the cointegration methodology. Cointegration tests show that DAX30, FTSE100, and SMI indexes move together in the long term. The VECM model indicates a positive long run relation among these indexes, while the error correction terms indicate that the Swiss market is the initial receptor of external shocks. One of the main findings of this analysis is that although the UK, Switzerland and Germany do not share a common currency, the diversification benefits of investing in these countries could be very low given that their stock markets seem to move together in the lung term.
    Keywords: Stock Returns; Volatility; GARCH models; Cointegration
    JEL: C53 G15 C22
    Date: 2008–11
  5. By: Naoto Kunitomo (Faculty of Economics, University of Tokyo); Seisho Sato (Institute of Statistical Mathematics)
    Abstract: For the estimation problem of the realized volatility, covariance and hedging coefficient by using high frequency data with possibly micro-market noises, we use the Separating Information Maximum Likelihood (SIML) method, which was recently developed by Kunitomo and Sato (2008). By analyzing the Nikkei 225 futures and spot index markets, we have found that the estimates of realized volatility, covariance and hedging coefficient have significant bias by the traditional method which should be corrected. Our method can handle the estimation bias and the tick-size effects of Nikkei 225 futures by removing the possible micro-market noise in multivariate high frequency data.
    Date: 2008–11
  6. By: Marco, Taboga
    Abstract: Around the turn of the Twentieth century, US and euro area long-term bond yields experienced a remarkable decline and remained at historically low levels even in the face of rising short-term rates (the so called "conundrum"). This unusual phenomenon has been analyzed by many researchers through the lens of macro-finance VARs and no-arbitrage term structure models. A commonly found result is that the decline in long-term rates was primarily driven by an unprecedented reduction in risk premia. I show that such result might be an artefact of the class of models employed to study the phenomenon. I propose an alternative model which suggests that, although risk premia played an important role in reducing bond yields, other two equally important forces were at play, i.e. a decline in the real natural rate of interest and a structural reduction in inflation expectations. I conclude that, after accounting for permanent shifts in the expectations about the future path of short-term rates, the dynamics of risk premia observed after the turn of the century have not been unusual if considered from an historical perspective.
    Keywords: Bond yields; forward premia; macro-finance models.
    JEL: E0 C32 G12
    Date: 2008–11–14
  7. By: Modena, Matteo
    Abstract: This work extends the strand of literature that examines the relation between the term structure of interest rates and macroeconomic variables. The yield curve is summarized by few latent factors (level, slope, and curvature) which are obtained through Kalman filtering. In this paper, we address the challenging issue of attributing an economic interpretation to the third unobservable component of the term structure, i.e. curvature. In particular, we find significant evidence suggesting that curvature reflects the cyclical fluctuations of the economy. Interestingly, this result holds in spite of whether the curvature factor is extracted from the nominal or the real term structure. A negative shock to curvature seems either to anticipate or to accompany a slowdown in economic activity. The curvature effect thus appears to complement the transition from an upward sloping yield curve to a flat one. Finally, a joint macro-econometric model for curvature and real activity is developed and estimated
    Keywords: Term Structure; Kalman Filtering; Latent Factors; Curvature; Business Cycle
    JEL: C32 E32 E44
    Date: 2008–09
  8. By: Koenig, Steven R.; Dodson, Charles B.
    Abstract: Past research on agricultural loan pricing is not extensive and has been hampered by a lack of suitable data. The Farm Service Agency (FSA) has guaranteed approximately 5 percent of farm debt of the Farm Credit System (FCS) and banks, the primary lenders to agriculture. As a requirement of the farm loan guarantee program, lenders must charge interest rates on these loans that are no different than their average or moderate risk farm loan customer. Therefore, rates on FSA guaranteed loans may be viewed as proxies for average farm loan interest rates. Using agency data bases, interest rates on nearly 100,000 farm loans guaranteed from fiscal 1999 to fiscal 2007 where compared with commercial farm loan rates and market-rate benchmarks. The study indicates that interest rates on FSA guaranteed loans are generally consistent with rates reported on various surveys of bank farm lending terms, but it also found that during certain periods guaranteed farm loan rates and non-guaranteed farm loan rates were less responsive to changes in market interest rates. In general, rates on guaranteed loans of the FCS were lower and more responsive to market rate conditions than guaranteed loans made by banks during the eight year study period.
    Keywords: Agricultural Finance,
    Date: 2008
  9. By: Li, Minqiang
    Abstract: It is known that actual option prices deviate from the Black-Scholes formula using the same volatility for different strikes. For the S&P 500 index options, we find that these deviations follow a stable pattern and are described by a simple function of at-the-money-forward total volatility. This im plies that the term structure of at-the-money-forward volatilities is su±cient to determine the entire volatility surface. We also find that the implied risk-neutral density is bimodal. The patterns we find are useful in predicting future implied volatilities.
    Keywords: Black Scholes formula; Implied volatility skew; Stable pattern; Risk-neutral density
    JEL: G13
    Date: 2008
  10. By: Carl Chiarella (School of Finance and Economics, University of Technology, Sydney); Viviana Fanelli (Dipartimento di Scienze Economiche, Matematiche e Statistiche, Università degli Studi di Foggia); Silvana Musti (Dipartimento di Scienze Economiche, Matematiche e Statistiche, Università degli Studi di Foggia)
    Abstract: In this paper a simulation approach for defaultable yield curves is developed within the Heath et al. (1992) framework. The default event is modelled using the Cox process where the stochastic intensity represents the credit spread. The forward credit spread volatility function is affected by the entire credit spread term structure. The paper provides the defaultable bond and CDS option price in a probability setting equipped with a subfiltration structure. The Euler-Maruyama stochastic integral approximation and the Monte Carlo method are applied to develop a numerical algorithm for pricing. Finally, the Antithetic Variables technique is used to reduce the variance of CDSO estimations.
    Keywords: HJM model; Cox process; Monte Carlo method; bond price; CDS option
    JEL: C63 G13 G33
    Date: 2008–10–01
  11. By: Jesús P. Colino; Francisco J. Nogales; Winfried Stute
    Abstract: In the current paper, we introduce a new calibration methodology for the LIBOR market model driven by LIBOR additive processes based in an inverse problem. This problem can be splitted in the calibration of the continuous and discontinuous part, linking each part of the problem with at-the-money and in/out -of -the-money swaption volatilies. The continuous part is based on a semidefinite programming (convex) problem, with constraints in terms of variability or robustness, and the calibration of the Lévy measure is proposed to calibrate inverting the Fourier Transform.
    Keywords: Lévy Market model, Calibration, Semidefinite programming
    Date: 2008–11
  12. By: Spargoli , Fabrizio (Universitat Pompeu Fabra and Università Politecnica delle Marche); Zagaglia, Paolo (Bank of Finland Research and Stockholm University)
    Abstract: This paper studies the co-movements between the daily returns of forwards on natural gas traded in the NYMEX with maturity of 1, 2 and 3 months. We identify a structural multivariate BEKK model using a recursive assumption whereby shocks to the volatility of the returns are transmitted from the short to the long section of the forward curve. We find strong evidence of spillover effects in the conditional first moments, for which we show that the transmission mechanism operates from the shorter to the longer maturity. In terms of reduced form conditional second moments, the shortest the maturity, the higher the volatility of the return, and the more the returns become independent from the others and follow the dynamics of the underlying commodity. The evidence from the structural second moments indicates that the longer the maturity is, the higher the uncertainty about the returns. We also show that the higher the structural variance of a maturity relative to that of another maturity, the stronger the correlation between the two.
    Keywords: natural gas prices; forward markets; GARCH; structural VAR
    JEL: C22 G19
    Date: 2008–11–18

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