New Economics Papers
on Financial Markets
Issue of 2009‒05‒16
five papers chosen by

  1. Identifying common dynamic features in stock returns By Jorge Caiado; Nuno Crato
  2. Carry trade and return crash risk By Mouhamadou Sy; Hamidreza Tabarraei
  3. Forecasting bank loans loss-given-default By Joao A. Bastos
  4. Credit Mismatch and Breakdown By Zsolt Becsi; Victor E. Li; Ping Wang
  5. Currency crises: The case of Iceland By Panagiotis Liargovas; Dimitrios Dapontas

  1. By: Jorge Caiado (CEMAPRE, School of Economics and Management (ISEG), Technical University of Lisbon); Nuno Crato (CEMAPRE, School of Economics and Management (ISEG), Technical University of Lisbon)
    Abstract: This paper proposes volatility and spectral based methods for cluster analysis of stock returns. Using the information about both the estimated parameters in the threshold GARCH (or TGARCH) equation and the periodogram of the squared returns, we compute a distance matrix for the stock returns. Clusters are formed by looking to the hierarchical structure tree (or dendrogram) and the computed principal coordinates. We employ these techniques to investigate the similarities and dissimilarities between the "blue-chip" stocks used to compute the Dow Jones Industrial Average (DJIA) index.
    Keywords: Asymmetric effects, Cluster analysis, DJIA stock returns, Periodogram, Threshold GARCH model, Volatility
    Date: 2009–05
  2. By: Mouhamadou Sy; Hamidreza Tabarraei
    Abstract: A model is developed in order to show that in the carry trade market the Sharpe ratio can be affected by the number of traders and it has a concave form. Hence, the Sharpe ratio does not increase with the interest rate differential. However, high interest rate currencies have greater currency crash risk exposure. The exchange rate movement, when there is no currency crash, does not affect so much the profit due to the carry trade, but the total profit is very sensitive to the exchange rate fluctuation. Skewness and Kurtosis are computed for 9 currencies as indexes for currency crash risk and Sharpe ratio is calculated as a proxy for profitability. In the empirical part, the Sharpe ratio shows a concave form and the model predict this concavity too. The model captures the effect of number of arbitrageurs in the carry trade market on the profit. In the last section, the exchange rate risk premium in this market is computed.
    Date: 2009
  3. By: Joao A. Bastos (CEMAPRE, School of Economics and Management (ISEG), Technical University of Lisbon)
    Abstract: With the advent of the new Basel Capital Accord, banking organizations are invited to estimate credit risk capital requirements using an internal ratings based approach. In order to be compliant with this approach, institutions must estimate the expected loss-given-default, the fraction of the credit exposure that is lost if the borrower defaults. This study evaluates the ability of a parametric fractional response regression and a nonparametric regression tree model to forecast bank loan credit losses. The out-of-sample predictive ability of these models is evaluated at several recovery horizons after the default event. The out-of-time predictive ability is also measured for a recovery horizon of one year. The performance of the models is benchmarked against recovery estimates given by a naive model in which predicted recoveries are given by historical averages.
    Keywords: Forecasting, bank loans, loss-given-default, fractional response regression, regression trees
    JEL: G21
    Date: 2009–05
  4. By: Zsolt Becsi (Department of Economics, Southern Illinois University Carbondale); Victor E. Li (Department of Economics and Statistics, Villanova School of Business, Villanova University); Ping Wang (Department of Economics, Washington University in St. Louis)
    Abstract: This paper studies the phenomenon of mismatch in a decentralized credit market where borrowers and lenders must engage in costly search to establish credit relationships. Our dynamic general equilibrium framework integrates incentive based informational frictions with a matching process highlighted by (i) borrowers’ endogenous market entry and exit decision (entry frictions) and (ii) time and resource costs necessary to locate credit opportunities (search frictions). A key feature of the incentive compatible loan contract negotiated between borrowers and lenders is the interaction of informational frictions (in the form of moral hazard) with entry and search frictions. We find that the removal of entry barriers can eliminate information-based equilibrium credit rationing. More generally, entry and incentive frictions are important in understanding the extent of credit rationing, while entry and search frictions are important for understanding credit market breakdown.
    Keywords: Entry, Moral Hazard, Credit Rationing, Credit Mismatch, Credit-Market Breakdown
    JEL: C78 D82 D83 E44
    Date: 2009–04
  5. By: Panagiotis Liargovas; Dimitrios Dapontas
    Abstract: This paper tries to explain the recent currency crisis in Iceland and draw some policy lessons. It shows that the recent currency crisis in Iceland is mainly due to a loose monetary policy preceding the crisis. Structural reforms which could have prevented the occurrence of the crisis were missing.
    Date: 2009

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