New Economics Papers
on Financial Markets
Issue of 2009‒03‒14
eight papers chosen by

  1. The Aftermath of Financial Crises By Reinhart, Carmen; Rogoff, Kenneth
  2. Extreme Value Theory and the Financial Crisis of 2008 By James P. Gander
  3. Are Stocks Really Less Volatile in the Long Run? By Pástor, Luboš; Stambaugh, Robert F
  4. Viability of Markets with an Infinite Number of Assets By Constantinos Kardaras
  5. Stock Markets in Low and Middle Income Countries By Ajit Singh
  6. EMU Effects on Stock Markets: From Home Bias to Euro Bias By Giofré, Maela/M.
  7. Institutional Trades and Herd Behavior in Financial Markets By Maria Grazia Romano
  8. Are Banks Different? Evidence from the CDS Market. By Burkhard Raunig; Martin Scheicher

  1. By: Reinhart, Carmen; Rogoff, Kenneth
    Abstract: This paper examines the depth and duration of the slump that invariably follows severe financial crises, which tend to be protracted affairs. We find that asset market collapses are deep and prolonged. On a peak-to-trough basis, real housing price declines average 35 percent stretched out over six years, while equity price collapses average 55 percent over a downturn of about three and a half years. Not surprisingly, banking crises are associated with profound declines in output and employment. The unemployment rate rises an average of 7 percentage points over the down phase of the cycle, which lasts on average over four years. Output falls an average of over 9 percent, although the duration of the downturn is considerably shorter than for unemployment. The real value of government debt tends to explode, rising an average of 86 percent in the major post-World War II episodes. The main cause of debt explosions is usually not the widely cited costs of bailing out and recapitalizing the banking system. The collapse in tax revenues in the wake of deep and prolonged economic contractions is a critical factor in explaining the large budget deficits and increases in debt that follow the crisis. Our estimates of the rise in government debt are likely to be conservative, as these do not include increases in government guarantees, which also expand briskly during these episodes.
    Keywords: duration; financial crisies; real estate; unemployment
    JEL: E44 F30 N20
    Date: 2009–03
  2. By: James P. Gander
    Abstract: The paper offers an alternative approach to analyzing stock market time series data. The purpose is to develop descriptive, more intuitive, and closer to reality analogs of the behavior of US stock market prices, as indexed by the S&P500 stock price index covering the period October 2003 to October 2008. One analog developed is the “escalator principle” and the blind man. The approach is to treat prices as a random and independent variable and use extreme value theory to judge probabilistically whether prices and their attributes are from an initial universe or whether there has been a regime change. The attributes include the level, first difference, second difference and third difference of the ordered price series. Various graphing tools are used, such as, probability paper and different specifications of exponential functions representing cumulative probability distributions. The argument is that traditional time-series analysis implies a given universe, usually normal with either a constant or time-dependent variance (or measureable risk) and consequently does not handle well uncertainty (non-measureable risk) due to regime changes. The analogs show the investor how to determine when a regime change has likely occurred.
    Keywords: S&P500, Probability, Regime, Uncertainty
    JEL: C19 C22 C49 G10
    Date: 2009–03
  3. By: Pástor, Luboš; Stambaugh, Robert F
    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.
    Keywords: long-run; risk; stock; variance
    JEL: G11 G23
    Date: 2009–03
  4. By: Constantinos Kardaras
    Abstract: A study of the boundedness in probability of the set of possible wealth outcomes of an economic agent is undertaken. The wealth-process set is structured with reasonable economic properties, instead of the usual practice of taking it to consist of stochastic integrals against a semimartingale integrator. We obtain the equivalence of the boundedness in probability of wealth outcomes with the existence of at least one supermartingale deflator, and, in case the set of wealth outcomes is closed in probability, with the existence of the num´eraire in the wealth-process set.
    Date: 2008–12–01
  5. By: Ajit Singh
    Abstract: This paper explores the question of whether the institution of the stock market is likely to be helpful to low and middle income countries in promoting development of their real economy and ensuring fast industrial growth. The case for and against the stock market inevitably involves a discussion of the important related subjects of corporate finance, corporate governance and corporate law. Contrary to the literature the paper arrives at a negative overall assessment of the institution of the stock market in relation to economic development. It also contributes by its policy proposals concerning the markets for corporate control which again are in conflict with much of the conventional wisdom on the subject.
    Keywords: stock market; market for corporate control; corporate finance; corporate governance; corporate law
    JEL: G1 G3
    Date: 2008–12
  6. By: Giofré, Maela/M.
    Abstract: The shift of perspective from a national basis to a Euro area basis, inevitably induced by EMU, has led member countries to a parallel shift from equity home bias to equity Euro bias. We interpret this evidence by means of a standard mean-variance portfolio selection model modified in order to include information asymmetries, considering the effect of the EMU integration process on equity markets through informational channels, real and financial. We find a stronger informational impact of the financial channel relative to the real channel in shaping EMU countries' equity portfolios after integration.
    Keywords: financial integration; portfolio choice; home bias; information asymmetries
    JEL: G11 G15 F21 F36
    Date: 2008–05
  7. By: Maria Grazia Romano (University of Salerno and CSEF)
    Abstract: The article studies the impact of transaction costs on the trading strategy of informed institutional investors in a sequential trading market where traders can choose to transact a large or a small amount of the stock. The analysis shows that high transaction costs may induce informed investors to herd. Moreover, for low levels of transaction costs, informed investors trade both the large and the small quantity of the asset. Finally, if transaction costs are very low and the market width is large enough, informed traders prefer to separate from small liquidity traders.
    Date: 2009–02–15
  8. By: Burkhard Raunig (Oesterreichische Nationalbank, Economic Studies Division, P.O. Box 61, A-1010 Vienna,); Martin Scheicher (European Central Bank, Kaiserstrasse 29, D – 60311, Frankfurt am Main, Germany,)
    Abstract: This paper uses regression analysis to compare the market pricing of the default risk of banks to that of other firms. We study how CDS traders discriminate between banks and other type of firms and how their judgement changes over time, in particular, since the start of the recent financial turmoil. We use monthly data on the Credit Default Swaps (CDS) of 41 major banks and 162 non-banks. By means of panel analysis, we decompose the CDS premia into the expected loss and the risk premium. Our primary result is that market participants indeed viewed banks differently and that they drastically changed their mind during the recent turmoil that started in August 2007.
    Keywords: Credit default swap, market discipline, default risk, risk premium
    JEL: E43 G12 G13
    Date: 2009–02–16

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