New Economics Papers
on Financial Markets
Issue of 2009‒02‒07
six papers chosen by

  1. The equity premium in 100 textbooks By Fernandez, Pablo
  2. Coupling Index and Stocks By Benjamin Jourdain; Mohamed Sbai
  3. Why Are Buyouts Levered? The Financial Structure of Private Equity Funds By Axelson, Ulf; Stromberg, Per; Weisbach, Michael S.
  4. Risk Management Failures: What Are They and When Do They Happen? By Stulz, Rene M.
  5. Risk-adjusted forecasts of oil prices By Patrizio Pagano; Massimiliano Pisani
  6. Derivatives Markets for Home Prices By Shiller, Robert J.

  1. By: Fernandez, Pablo (IESE Business School)
    Abstract: I review 100 finance and valuation textbooks published between 1979 and 2008 by authors such as Brealey and Myers, Copeland, Damodaran, Merton, Ross, Bruner, Bodie, Penman, Weston, Brigham and Arzac and find that their recommendations regarding the equity premium range from 3% to 10%. I also find that several books use different equity premia on different pages. Some of the confusion arises from not distinguishing among the four concepts that the term equity premium designates: historical equity premium, expected equity premium, required equity premium and implied equity premium. Finance textbooks should clarify the equity premium by providing distinguishing definitions of these four concepts and conveying a clearer message about their sensible magnitudes.
    Keywords: equity premium; equity premium puzzle; required market risk premium; historical market risk premium; expected market risk premium; risk premium; market risk premium; market premium;
    JEL: G12 G31 G32
    Date: 2008–07–13
  2. By: Benjamin Jourdain (CERMICS - Centre d'Enseignement et de Recherche en Mathématiques, Informatique et Calcul Scientifique - INRIA - Ecole Nationale des Ponts et Chaussées); Mohamed Sbai (CERMICS - Centre d'Enseignement et de Recherche en Mathématiques, Informatique et Calcul Scientifique - INRIA - Ecole Nationale des Ponts et Chaussées)
    Abstract: In this paper, we are interested in continuous time models in which the index level induces some feedback on the dynamics of its composing stocks. More precisely, we propose a model in which the log-returns of each stock may be decomposed into a systemic part proportional to the log-returns of the index plus an idiosyncratic part. We show that, when the number of stocks in the index is large, this model may be approximated by a local volatility model for the index and a stochastic volatility model for each stock with volatility driven by the index. We address calibration of both the limit and the original models.
    Keywords: Index modeling, calibration, non-parametric estimation
    Date: 2008–12–17
  3. By: Axelson, Ulf (Stockholm School of Economics and SIFR); Stromberg, Per (Stockholm School of Economics and SIFR); Weisbach, Michael S. (Ohio State U)
    Abstract: Private equity funds are important actors in the economy, yet there is little analysis explaining their financial structure. In our model the financial structure minimizes agency conflicts between fund managers and investors. Relative to financing each deal separately, raising a fund where the manager receives a fraction of aggregate excess returns reduces incentives to make bad investments. Efficiency is further improved by requiring funds to also use deal-by-deal debt financing, which becomes unavailable in states where internal discipline fails. Private equity investment becomes highly sensitive to economy-wide availability of credit and investments in bad states outperform investments in good states.
    Date: 2008–09
  4. By: Stulz, Rene M. (Ohio State U and ECGI)
    Abstract: A large loss is not evidence of a risk management failure because a large loss can happen even if risk management is flawless. I provide a typology of risk management failures and show how various types of risk management failures occur. Because of the limitations of past data in assessing the probability and the implications of a financial crisis, I conclude that financial institutions should use scenarios for credible financial crisis threats even if they perceive the probability of such events to be extremely small.
    Date: 2008–10
  5. By: Patrizio Pagano (Bank of Italy, via Nazionale 91, I - 00184 Rome, Italy.); Massimiliano Pisani (Bank of Italy, via Nazionale 91, I - 00184 Rome, Italy.)
    Abstract: This paper documents the existence of a significant forecast error on crude oil futures. We interpret it as a risk premium, which, in part, could have been explained by means of a real-time US business cycle indicator, such as the degree of capacity utilization in manufacturing. This result is robust to the specification of the estimating equation and to the considered business cycle indicator. An out-of-the-sample prediction exercise reveals that futures adjusted to take into account this time-varying component produce significantly better forecasts than those of unadjusted futures, of futures adjusted for the average forecast error and of the random walk, particularly at horizons of more than 6 months. JEL Classification: E37, E44, G13, Q4.
    Keywords: Oil, Forecasting, Futures.
    Date: 2009–01
  6. By: Shiller, Robert J. (Yale U)
    Abstract: The establishment recently of risk management vehicles for home prices is described. The potential value of such vehicles, once they become established, is seen in consideration of the inefficiency of the market for single family homes. Institutional changes that might derive from the establishment of these new markets are described. An important reason for these beginnings of real estate derivative markets is the advance in home price index construction methods, notably the repeat sales method, that have appeared over the last twenty years. Psychological barriers to the full success of such markets are discussed.
    JEL: G13
    Date: 2008–03

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