New Economics Papers
on Financial Markets
Issue of 2009‒02‒28
thirteen papers chosen by

  1. Overcoming the Financial Crisis By Andrea de Michelis
  2. Global Financial Crisis: Causes and Lessons - A Neo-Schumpeterian perspective By Horst Hanusch; Florian Wackermann
  3. Banking Crises: An Equal Opportunity Menace By Reinhart, Carmen; Rogoff, Kenneth
  4. Stock-Market Crashes and Depressions By Robert J. Barro; Jose Ursua
  5. The Future of Securities Regulation By Zingales, Luigi
  6. Learning in Financial Markets By Pástor, Luboš; Veronesi, Pietro
  7. Are Stocks Really Less Volatile in the Long Run? By Lubos Pastor; Robert F. Stambaugh
  8. Why do risk premia vary over time? A theoretical investigation under habit formation By De Paoli, Bianca; Zabczyk, Pawel
  9. The Benefits of Financial Markets: A Case Study of European Football Clubs By Dirk G. Baur and Conor McKeating
  10. Euro corporate bonds risk factors By Castagnetti, Carolina; Rossi, Eduardo
  11. Rollover Risk and Market Freezes By Acharya, Viral V; Gale, Douglas M; Yorulmazer, Tanju
  12. Financial Market Integration Under EMU By Jappelli, Tullio; Pagano, Marco
  13. Domestic or U.S. News: What Drives Canadian Financial Markets? By Bernd Hayo; Matthias Neuenkirch

  1. By: Andrea de Michelis
    Abstract: The global financial crisis that emerged in mid 2007 has caused considerable economic disruptions in the United States and elsewhere, and exposed major flaws in the global financial system. After examining the origins of the crisis, this paper recommends specific policy responses to resolve the immediate problems and discusses how to make the US financial system more resilient and stable in the future.<P>Surmonter la crise financière<BR>La crise financière qui a éclaté à la mi-2007 a provoqué des perturbations économiques considérables aux États-Unis et ailleurs, et révélé des failles majeures dans le système financier mondial. Après une analyse des origines de la crise, ce chapitre préconise des réponses spécifiques pour résoudre les problèmes immédiats et étudie les moyens de rendre le système financier des États-Unis plus résilient et plus stable dans l’avenir.
    Keywords: United States, États-Unis, surveillance prudentielle, financial regulation, financial crisis, crise financière, deleveraging, housing finance, financement du logement, financial supervision, réglementation des marchés financiers, market stability regulator, securitisation, subprime mortgage, autorité de contrôle pour la stabilité des marchés financiers, crédit hypothécaire à risques, réduction de l’effet de levier, titrisation
    JEL: E44 G20 G21 G28 R21
    Date: 2009–02–24
  2. By: Horst Hanusch (University of Augsburg, Department of Economics); Florian Wackermann (University of Augsburg, Department of Economics)
    Abstract: This paper analyses the current financial crisis from a Neo-Schumpeterian perspective. We postulate four linkages that led to the crisis, and that will help us find our way out of the crisis. Therefore, we show that the current evolution is very similar to the Japanese crisis in the beginning of the 1990s. Furthermore, we address the issue why the world was faced with this crisis in such an unprepared way and look at the deficiencies in current economic theories that are responsible for the fact that we did not foresee this development. Besides, we elaborate that the crisis is not a systemic default of the capitalistic system but that it is rather a consequence of its enormous success. Finally, we propose the Neo-Schumpeterian Corridor as a theoretical framework that can help avoid such dramatic evolutions as the current crisis and look at possibilities to overcome this situation.
    Keywords: financial crisis, Neo-Schumpeterian Corridor, crisis evolution, governmental role
    JEL: B52 H11 N20 O20
    Date: 2009–02
  3. By: Reinhart, Carmen; Rogoff, Kenneth
    Abstract: The historical frequency of banking crises is quite similar in high- and middle-to-low-income countries, with quantitative and qualitative parallels in both the run-ups and the aftermath. We establish these regularities using a unique dataset spanning from Denmark’s financial panic during the Napoleonic War to the ongoing global financial crisis sparked by subprime mortgage defaults in the United States. Banking crises dramatically weaken fiscal positions in both groups, with government revenues invariably contracting, and fiscal expenditures often expanding sharply. Three years after a financial crisis central government debt increases, on average, by about 86 percent. Thus the fiscal burden of banking crisis extends far beyond the commonly cited cost of the bailouts. Our new dataset includes housing price data for emerging markets; these allow us to show that the real estate price cycles around banking crises are similar in duration and amplitude to those in advanced economies, with the busts averaging four to six years. Corroborating earlier work, we find that systemic banking crises are typically preceded by asset price bubbles, large capital inflows and credit booms, in rich and poor countries alike.
    Keywords: bail out; banking; crisis; debt; equity prices; house prices
    JEL: E6 F3 N10
    Date: 2009–01
  4. By: Robert J. Barro; Jose Ursua
    Abstract: Long-term data for 25 countries up to 2006 reveal 195 stock-market crashes (multi-year real returns of -25% or less) and 84 depressions (multi-year macroeconomic declines of 10% or more), with 58 of the cases matched by timing. The United States has two of the matched events - the Great Depression 1929-33 and the post-WWI years 1917-21, likely driven by the Great Influenza Epidemic. 45% of the matched cases are associated with war, and the two world wars are prominent. Conditional on a stock-market crash, the probability of a minor depression (macroeconomic decline of at least 10%) is 30% and of a major depression (at least 25%) is 11%. In a non-war environment, these probabilities are lower but still substantial - 20% for a minor depression and 3% for a major depression. Thus, the stock-market crashes of 2008-09 in the United States and other countries provide ample reason for concern about depression. In reverse, the probability of a stock-market crash is 69%, conditional on a depression of 10% or more, and 91% for 25% or more. Thus, the largest depressions are particularly likely to be accompanied by stock-market crashes, and this finding applies equally to non-war and war events. We allow for flexible timing between stock-market crashes and depressions for the 58 matched cases to compute the covariance between stock returns and an asset-pricing factor, which depends on the proportionate decline of consumption during a depression. If we assume a coefficient of relative risk aversion around 3.5, this covariance is large enough to account in a familiar looking asset-pricing formula for the observed average (levered) equity premium of 7% per year. This finding complements previous analyses that were based on the probability and size distribution of macroeconomic disasters but did not consider explicitly the covariance between macroeconomic declines and stock returns.
    JEL: E01 E21 E23 E44 G12
    Date: 2009–02
  5. By: Zingales, Luigi
    Abstract: The U.S. system of security law was designed more than 70 years ago to regain investors’ trust after a major financial crisis. Today we face a similar problem. But while in the 1930s the prevailing perception was that investors had been defrauded by offerings of dubious quality securities, in the new millennium, investors’ perception is that they have been defrauded by managers who are not accountable to anyone. For this reason, I propose a series of reforms that center around corporate governance, while shifting the focus from the protection of unsophisticated investors in the purchasing of new securities issues to the investment in mutual funds, pension funds, and other forms of asset management.
    Keywords: coorporate goverance; security regulation
    JEL: G18 G38 K22
    Date: 2009–01
  6. By: Pástor, Luboš; Veronesi, Pietro
    Abstract: We survey the recent literature on learning in financial markets. Our main theme is that many financial market phenomena that appear puzzling at first sight are easier to understand once we recognize that parameters in financial models are uncertain and subject to learning. We discuss phenomena related to the volatility and predictability of asset returns, stock price bubbles, portfolio choice, mutual fund flows, trading volume, and firm profitability, among others.
    Keywords: Bayesian; bubble; predictability; uncertainty; volatility
    JEL: G0
    Date: 2009–01
  7. By: Lubos Pastor; Robert F. Stambaugh
    Abstract: Conventional wisdom views stocks as less volatile over long horizons than over short horizons due to mean reversion induced by return predictability. In contrast, we find stocks are substantially more volatile over long horizons from an investor's perspective. This perspective recognizes that parameters are uncertain, even with two centuries of data, and that observable predictors imperfectly deliver the conditional expected return. We decompose return variance into five components, which include mean reversion and various uncertainties faced by the investor. Although mean reversion makes a strong negative contribution to long-horizon variance, it is more than offset by the other components. Using a predictive system, we estimate annualized 30-year variance to be nearly 1.5 times the 1-year variance.
    JEL: G11 G12 G23
    Date: 2009–02
  8. By: De Paoli, Bianca (Bank of England); Zabczyk, Pawel (Bank of England)
    Abstract: Empirical evidence suggests that risk premia are higher at business cycle troughs than they are at peaks. Existing asset pricing theories ascribe moves in risk premia to changes in volatility or risk aversion. Nevertheless, in a simple general equilibrium model, risk premia can be procyclical even though the volatility of consumption is constant and despite a countercyclically varying risk aversion coefficient. We show that agents' expectations about future prospects also influence premium dynamics. In order to generate countercyclically varying premia, as found in the data, one requires a combination of hump-shaped consumption dynamics or highly persistent shocks and habits. Our results, thus, suggest that factors which help match activity data may also help along the asset pricing dimension.
    Date: 2009–02–16
  9. By: Dirk G. Baur and Conor McKeating
    Abstract: This study analyses the performance of European football clubs which undergo an initial public offering (IPO). We use a unique time-series and cross-section dataset consisting of domestic and international performance data to develop an event study to investigate the effects of a football club’s on-field performance before and after the IPO. The study follows from the observation that, as financial markets are expected to exhibit a positive influence on the economy as a whole, football clubs who access these markets should benefit as well. However, the conclusions of our study are similar to those in the corporate finance literature, where firms who undertake an IPO find their stock price underperforming similar firms in the medium term. Using our metric, football clubs have a diminished domestic and international performance after the stock market listing.
    Date: 2009–02–16
  10. By: Castagnetti, Carolina; Rossi, Eduardo
    Abstract: This paper investigates the determinants of credit spread changes in Euro-denominated bonds. Because credit spread changes can be easily viewed as an excess return on corporate bonds over treasury bonds, we adopt a factor model framework, inspired by the credit risk structural approach. We try to assess the relative importance of market and idiosyncratic factors in explaining the movements in credit spreads. We adopt a heterogeneous panel with a multifactor error model and propose a two-step estimation procedure which yields consistent estimates of unobserved factors. The analysis is carried out with a panel of monthly redemption yields on a set of corporate bonds for a time span of three years. Our results suggest that the Euro corporate market is driven by observable and unobservable factors. Where the latter are identified through a consistent estimation of individual and common observable effects. We observe that the factors predicted by the structural model are not as relevant as in the case of the US market. The empirical results also suggest that an unobserved common factor has a significant role in explaining the systematic changes in credit spreads. However, contrary to the American evidence, it cannot be identified as a market factor.
    Keywords: Euro Corporate Bonds; Cross Section Dependence; Common Correlated Effects; Yield Curve
    JEL: G10
    Date: 2008–10–16
  11. By: Acharya, Viral V; Gale, Douglas M; Yorulmazer, Tanju
    Abstract: We consider the debt capacity of a risky asset when debt is being rolled over and there is a liquidation cost in case of default. We show that debt capacity depends on how information about the quality of the asset is revealed. When the information structure is based on “optimistic” expectations, the arrival of no news about the asset is good news; under this structure, debt capacity does not depend upon rollovers and liquidation cost, and is simply equal to expected cash flows from the asset. In contrast, when the information structure is based on “pessimistic” expectations, no news about the asset is bad news; under this structure, debt capacity of the asset is decreasing in the liquidation cost and frequency of rollovers. In the limit, as the number of rollovers becomes unbounded, the debt capacity goes to zero even for an arbitrarily small default risk. Our model explains why markets for rollover debt, such as asset-backed commercial paper, may experience sudden freezes. The model also provides an explicit formula for the haircut in secured borrowing or repo transactions.
    Keywords: asset-backed commercial paper; credit risk; haircut; liquidation cost; repo; secured borrowing
    JEL: D8 G12 G21 G24 G32 G33
    Date: 2009–01
  12. By: Jappelli, Tullio; Pagano, Marco
    Abstract: The single most important policy-induced innovation in the international financial system since the collapse of the Bretton-Woods regime is the institution of the European Monetary Union. This paper provides an account of how the process of financial integration has promoted financial development in the euro area. It starts by defining financial integration and how to measure it, analyzes the barriers that can prevent it and the effects of their removal on financial markets, and assesses whether the euro area has actually become more integrated. It then explores to which extent these changes in financial markets have influenced the performance of the euro-area economy, that is, its growth and investment, as well as its ability to adjust to shocks and to allow risk-sharing. The paper concludes analyzing further steps that are required to consolidate financial integration and enhance the future stability of financial markets.
    Keywords: EMU; financial market integration
    JEL: G20
    Date: 2008–12
  13. By: Bernd Hayo (Faculty of Business Administration and Economics, Philipps-University Marburg); Matthias Neuenkirch (Faculty of Business Administration and Economics, Philipps-University Marburg)
    Abstract: Using a GARCH model, we study the effects of Canadian and U.S. central bank communication and macroeconomic news on Canadian bond, stock, and foreign exchange market returns and volatility. First, news in both categories and from both countries has an impact on all financial markets. Canadian and U.S. price shocks and monetary policy news are less important than shocks relating to the real economy. Second, Canadian central bank communication is more relevant than its U.S. counterpart, whereas in the case of macro news that originating from the United States dominates. Third, we find evidence that the impact of Canadian news reaches its maximum when the Canadian target rate departs from the Federal Funds target rate (2002–2004). The introduction of fixed announcement dates (FAD) does not cause a noticeable break in the data. Finally, Canadian and U.S. target rate changes lead to higher price volatility, and so does other U.S. news. Other Canadian news, however, lowers price volatility.
    Keywords: Bank of Canada, Central Bank Communication, Federal Reserve Bank, Financial Markets, Macroeconomic News, Monetary Policy
    JEL: E52 G14 G15
    Date: 2009

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