New Economics Papers
on Financial Markets
Issue of 2009‒02‒22
six papers chosen by

  1. The Credit Crisis: Conjectures about Causes and Remedies By Douglas W. Diamond; Raghuram Rajan
  2. The sub-prime crisis, the credit squeeze, Northern Rock and beyond: The lessons to be learnt By Maximilian J. B. Hall
  3. How Media Make People Buy Stocks: Market Homogeneity and Bubbles By Leif Brandes; Katja Rost
  4. Herd behavior towards the market index: Evidence from 21 financial markets By Wang, Daxue
  5. How Do Mutual Fund Fees Affect Investor Choices? Evidence from Survey Experiments By Jeff Dominitz; Angela A. Hung; Joanne K. Yoong
  6. Volatility in Equilibrium: Asymmetries and Dynamic Dependencies By Tim Bollerslev; Natalia Sizova; George Tauchen

  1. By: Douglas W. Diamond; Raghuram Rajan
    Abstract: What caused the financial crisis that is sweeping across the world? What keeps asset prices and lending depressed? What can be done to remedy matters? While it is too early to arrive at definite answers to these questions, it is certainly time to offer informed conjectures, and these are the focus of this paper.
    JEL: E52 F33 G21
    Date: 2009–02
  2. By: Maximilian J. B. Hall (Dept of Economics, Loughborough University)
    Abstract: On 14 September 2007, after failing to find a 'White Knight' to take over its business, Northern Rock bank turned to the Bank of England ('the Bank') for a liquidity lifeline. This was duly provided but failed to quell the financial panic, which manifested itself in the first fully-blown nationwide deposit run on a UK bank for 140 years. Subsequent provision of a blanket deposit guarantee duly led to the (eventual) disappearance of the depositor queues from outside the bank's branches but only served to heighten the sense of panic in policymaking circles. Following the Government's failed attempt to find an appropriate private sector buyer, the bank was then nationalised in February 2008. Inevitably, post mortems ensued, the most transparent of which was that conducted by the all-party House of Commons' Treasury Select Committee. And a variety of reform proposals are currently being deliberated at fora around the globe with a view to patching up the global financial system to prevent a recurrence of the events which precipitated the bank's illiquidity and the wider financial instability which set in towards the end of 2008. This article briefly explains the background to these extraordinary events before setting out, in some detail, the tensions and flaws in UK arrangements which allowed the Northern Rock spectacle to occur. None of the interested parties – the Bank, the Financial Services Authority (FSA) and the Treasury – emerges with their reputation intact, and the policy areas requiring immediate attention, at both the domestic and international level, are highlighted. A review and assessment of both the House of Commons Treasury Committee's Report on Northern Rock and the Tripartite Authorities' proposals for reform are also provided before analysis of the subsequent measures taken to stabilise the UK financial sector – involving further nationalisation of banks, the brokering of takeover rescues of banks and building societies, a £400 billion bailout of the deposit-taking sector and a subsequent bank bailout scheme – is undertaken. Accordingly, this paper represents an update, covering developments until end-January 2009, of my earlier paper on the Northern Rock affair (Working Paper No. WP 2008-09), which was published in September 2008. Specifically, it covers the latest domestic (i.e. UK) developments on a number of fronts. The text, for example, provides updates on the reform proposals of the Tripartite Authorities, amendments to deposit protection arrangements, and the emergency funding initiatives adopted by the Bank of England. Table 2 (where, along with Table 1, most of the new material is located), meanwhile, provides updates and analysis of the following: the latest developments in the UK housing market; the latest developments in the real economy; the latest financial statements of the major banks; the latest nationalisation moves;* the latest inflation figures and interest rate decisions of the MPC; the latest government bailout plans for deposit-takers; the latest official support packages introduced for the housing market, mortgage borrowers and small businesses; the latest fiscal stimulus plans (e.g. as contained in the Pre-Budget Report of November 2008); and the latest domestic financial and regulatory developments. Meanwhile, Table 1 provides up-to-date information on: emergency funding initiatives undertaken by the Fed, the ECB and other major central banks; financial institution takeovers/bailouts in the US and Europe; interest rate developments in the major economies; financial and regulatory developments in the US and Europe; developments in the real economies of the US and Europe; the financial statements of banks in the USA and Europe; the evolution of official bailout plans in the US ('TARP') and Europe; deposit protection developments in the US and Europe; fiscal stimulus packages adopted in the US, Europe and the wider international community; G7/EU plans to tackle the worsening financial crisis; IMF 'bailouts' of beleaguered countries; and the Basel Committee's proposals for revamping Basel II in the light of the crisis. *A more detailed discussion of these developments is provided in Hall (2008).
    Keywords: Sub-prime crisis; credit crunch; banking regulation and supervision; failure resolution; central banking; deposit protection.
    JEL: E53 E58 G21 G28
    Date: 2009–01
  3. By: Leif Brandes (Institute for Strategy and Business Economics, University of Zurich); Katja Rost (Institute of Organization and Administrative Science, University of Zurich)
    Abstract: Recent evidence shows that individual traders act surprisingly systematic. This paper analyzes the factors that cause such behavior. Using survey data for more than 300 individuals, we support previous results and provide a simple explanation for this: the strong tendency of individuals to rely on media information for investment purposes. We are the first to study media impact by analyzing an individualÕs propensity to buy stocks while controlling for a broad class of individual characteristics. We show that the media are the only information resource within our study, for which the marginal effect on the propensity to buy stocks increases substantially (from 48% to 89%) when controlling for investment motives, preferred asset classes, personal financial experience, and gender. While we explain the importance of the media by the notion of persuasion bias and overconfidence, our results imply that the impact of media on markets increases substantially if noise traders become more homogeneous as a group. We conclude that the relation between media influence and homogeneity of traders can be one important driver for speculative bubbles.
    Keywords: noise traders; selection models; media
    JEL: C25 D83 G11 G14
    Date: 2009
  4. By: Wang, Daxue (IESE Business School)
    Abstract: This paper uses the cross-sectional variance of the betas to study herd behavior towards the market index in major developed and emerging financial markets (categorized as Developed group, Asian group, and Latin American group). We propose a robust regression technique to calculate the betas of the CAPM and those of the Fama-French three-factor model, with to the aim of diminishing the impact of multivariate outliers in return data. Through the estimated values obtained from a state space model, we examine the evolution of herding measures, especially their pattern around sudden events such as the 1997-1998 financial crises. This 1997-1998 turmoil turns out to have formed a turning point for most of the financial markets. We document a higher level of herding in emerging markets than in developed markets. We also find that the correlation of herding is higher between two markets from the same group than between two markets from different groups. This paper sheds light on the calculation of beta and on the financial policy to understand the dynamics of herding in financial markets.
    Keywords: Herding; Outlier; Robust Regression; Cycle;
    JEL: C60 G12 G14 G15
    Date: 2008–12–05
  5. By: Jeff Dominitz; Angela A. Hung; Joanne K. Yoong
    Abstract: Over the past few decades, risks associated with providing for financial security in retirement have increasingly shifted from employers to employees as employer-provided pensions have shifted from defined-benefit to defined-contribution (DC) plans. Recent work in behavioral finance suggests that investors do not make optimal investment decisions in their DC plans. The authors designed and administered a pair of mutual fund choice experiments to over 1000 survey respondents who participate in the RAND American Life Panel. Their analysis sheds light on the question of how mutual fund investors respond to variation in fees in a hypothetical scenario in which fees should be obvious to the investor. The results show that some aspects of individual behavior are consistent with rational wealth-maximization and the majority of the respondents are able to provide estimates of fees that lie within a benchmark range. However, they find that respondents tend not to minimize expected fees and are more averse to backend load fees than to front-end loads. The trade-off between expense ratios and loads is found to be somewhat sensitive to the expected holding period in a manner consistent with expected-wealth maximization, but investors may tend to be too averse to loads. Differences in measured financial literacy predict differences in behavior, with lower rates of literacy among women accounting for differences in choice behavior by gender. They also find that financial literacy mediates individual responses to the presentation of information intended to enhance decision making.
    JEL: D14 D83 D91
    Date: 2008–12
  6. By: Tim Bollerslev (Department of Economics, Duke University and CREATES); Natalia Sizova (Department of Economics, Duke University); George Tauchen (Department of Economics, Duke University)
    Abstract: Stock market volatility clusters in time, carries a risk premium, is fractionally inte- grated, and exhibits asymmetric leverage effects relative to returns. This paper develops a first internally consistent equilibrium based explanation for these longstanding empirical facts. The model is cast in continuous-time and entirely self-contained, in- volving non-separable recursive preferences. We show that the qualitative theoretical implications from the new model match remarkably well with the distinct shapes and patterns in the sample autocorrelations of the volatility and the volatility risk pre- mium, and the dynamic cross-correlations of the volatility measures with the returns calculated from actual high-frequency intra-day data on the S&P 500 aggregate market and VIX volatility indexes.
    Keywords: Equilibrium asset pricing; stochastic volatility; leverage effect; volatility feed- back; option implied volatility; realized volatility; variance risk premium.
    JEL: C22 C51 C52 G12 G13 G14
    Date: 2009–02–17

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