nep-fmk New Economics Papers
on Financial Markets
Issue of 2009‒12‒19
eight papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Financial Market Regulation in the Wake of Financial Crises: The Historical Experience By Alfredo Gigliobianco (editor); Gianni Toniolo (editor)
  2. Prudential Regulation and Competition in Financial Markets By Rudiger Ahrend; Jens Arnold; Fabrice Murtin
  3. Quantifying High-Frequency Market Reactions to Real-Time News Sentiment Announcements By Axel Groß-Klußmann; Nikolaus Hautsch
  4. Multifractal dynamics of stock markets By Dariusz Grech; Lukasz Czarnecki
  5. Forecasting the Yield Curve for Brazil By Daniel O. Cajueiro; Jose A. Divino; Benjamin M. Tabak
  6. "Realized Volatility Risk" By David E. Allen; Michael McAleer; Marcel Scharth
  7. Optimal option pricing and trading: a new theory By Moawia, Alghalith
  8. Systematic risk of CDOs and CDO arbitrage By Hamerle, Alfred; Liebig, Thilo; Schropp, Hans-Jochen

  1. By: Alfredo Gigliobianco (editor) (Bank of Italy, Structural Economic Analysis Department); Gianni Toniolo (editor) (Duke University)
    Abstract: The focus of the present volume - which originates from a workshop held at the Bank of Italy on 16 and 17 April 2009 - is the regulatory response given to financial crises in the past, across countries. Alongside the scholarly interest of such a review its aim is also to offer some insights that may be useful in re-designing regulation in the present time of distress.Financial crises have been examined under many perspectives, including that of regulatory failures. The studies assembled in this volume, which touch on a significant array of countries, can be viewed as part of a historical survey on this issue. The basic question is whether regulatory responses form a pattern, and more specifically, whether they tend to be biased with respect to an optimum, however defined. In the end, rather than finding one pattern of response, we were able to identify the "disturbances" which most often enter the post-crisis decisional process. The awareness of such factors, and some knowledge of their functioning, are instrumental in understanding (for academics) and in governing (for policy makers) the response to major financial crises.
    Keywords: Financial crises, financial regulation, economic history
    JEL: G28 N20
    Date: 2009–11
  2. By: Rudiger Ahrend; Jens Arnold; Fabrice Murtin
    Abstract: This paper examines how a range of stability-oriented regulatory policies for banking and insurance are related to selected stability and competition outcomes in these sectors. Based on survey information on financial market regulation, policy indicators for eight areas of prudential banking regulation are constructed, in addition to indicators for the insurance sector. Despite incomplete information on some areas that turned out to be important in the context of the recent financial crisis, the indicators correlate well with different measures of financial stability, both during the recent crisis and beyond. Furthermore, the results do not support the view that there is a general trade-off between stability-oriented regulatory policies and competition in banking and insurance.<P>Régulation prudentielle et concurrence sur les marchés financiers<BR>Cette étude examine le lien entre les politiques de régulation prudentielle des industries de la banque et de l’assurance et les résultats observés dans ces secteurs en termes de stabilité et de concurrence. Sur la base d’enquêtes portant sur la régulation des marchés financiers, des indicateurs sont construits pour évaluer les politiques touchant à huit segments différents de la régulation bancaire prudentielle, ainsi qu‘au secteur de l’assurance. En dépit de lacunes dans le renseignement de certains segments de la régulation, lacunes préjudiciables dans le contexte récent de crise financière, ces indicateurs présentent une corrélation satisfaisante avec diverses mesures de stabilité financière, à la fois dans ce contexte de crise et au-delà. En outre, les résultats ne confirment pas l’hypothèse qu’il y aurait en général un arbitrage entre la régulation prudentielle et la concurrence dans les secteurs de la banque et de l’assurance.
    Keywords: banking, competition, insurance, prudential regulation, stability, assurance, banque, concurrence, régulation prudentielle, stabilité
    JEL: E44 G14 G21 G22 G28 L11
    Date: 2009–12–01
  3. By: Axel Groß-Klußmann; Nikolaus Hautsch
    Abstract: We examine intra-day market reactions to news in stock-specific sentiment disclosures. Using pre-processed data from an automated news analytics tool based on linguistic pattern recognition we extract information on the relevance as well as the direction of company-specific news. Information-implied reactions in returns, volatility as well as liquidity demand and supply are quantified by a high-frequency VAR model using 20 second intervals. Analyzing a cross-section of stocks traded at the London Stock Exchange (LSE), we find market-wide robust news-dependent responses in volatility and trading volume. However, this is only true if news items are classified as highly relevant. Liquidity supply reacts less distinctly due to a stronger influence of idiosyncratic noise. Furthermore, evidence for abnormal highfrequency returns after news in sentiments is shown.
    Keywords: firm-specific news, news sentiment, high-frequency data, volatility, liquidity, abnormal returns
    JEL: G14 C32
    Date: 2009–12
  4. By: Dariusz Grech; Lukasz Czarnecki
    Abstract: We present a comparative analysis of multifractal properties of financial time series built on stock indices from developing (WIG) and developed (S&P500) financial markets. It is shown how the multifractal image of the market is altered with the change of the length of time series and with the economic situation on the market. We emphasize that the proper adjustment of scaling range for multiscaling power laws is essential to obtain the multifractal image of time series. We analyze in this paper multifractal properties of real financial time series using H\"older $f(\alpha)$ representation and multifractal-DFA method. It is also investigated how multifractal properties of stocks change with variety of "surgeries" done on the initial real financial time series. This way we reveal main phenomena on the market influencing its multifractal dynamics. In particular, we focus on examining how multifractal picture of real time series changes when one cuts off extreme events like crashes or rupture points, and how fluctuations around the main trend in time series influence the multifractal behavior of financial series in the long-time horizon for both developed and developing markets.
    Date: 2009–12
  5. By: Daniel O. Cajueiro; Jose A. Divino; Benjamin M. Tabak
    Date: 2009–11
  6. By: David E. Allen (School of Accounting, Finance and Economics, Edith Cowan University); Michael McAleer (Econometric Institute, Erasmus School of Economics, Erasmus University Rotterdam and Tinbergen Institute); Marcel Scharth (VU University Amsterdam and Tinbergen Institute)
    Abstract: In this paper we document that realized variation measures constructed from high-frequency returns reveal a large degree of volatility risk in stock and index returns, where we characterize volatility risk by the extent to which forecasting errors in realized volatility are substantive. Even though returns standardized by ex post quadratic variation measures are nearly gaussian, this unpredictability brings considerably more uncertainty to the empirically relevant ex ante distribution of returns. Carefully modeling this volatility risk is fundamental. We propose a dually asymmetric realized volatility (DARV) model, which incorporates the important fact that realized volatility series are systematically more volatile in high volatility periods. Returns in this framework display time varying volatility, skewness and kurtosis. We provide a detailed account of the empirical advantages of the model using data on the S&P 500 index and eight other indexes and stocks.
    Date: 2009–12
  7. By: Moawia, Alghalith
    Abstract: We introduce a new utility-based approach to pricing European and American options. In so doing, we overcome some of the limitations of the existing models.
    Keywords: option; derivative; asset; stochastic
    JEL: G12 G11
    Date: 2009–12–14
  8. By: Hamerle, Alfred; Liebig, Thilo; Schropp, Hans-Jochen
    Abstract: “Arbitrage CDOs” have recorded an explosive growth during the years before the outbreak of the financial crisis. In the present paper we discuss potential sources of such arbitrage opportunities, in particular arbitrage gains due to mispricing. For this purpose we examine the risk profiles of Collateralized Debt Obligations (CDOs) in some detail. The analyses reveal significant differences in the risk profile between CDO tranches and corporate bonds, in particular concerning the considerably increased sensitivity to systematic risks. This has farreaching consequences for risk management, pricing and regulatory capital requirements. A simple analytical valuation model based on the CAPM and the single-factor Merton model is used in order to keep the model framework simple. Then, the conditional expected loss curve (EL profile) is studied in some detail. In the next step, the asset correlation associated with a CDO tranche is estimated treating the structured instrument as a single-name credit instrument (i.e., a loan equivalent). While tractable, the loan-equivalent approach requires appropriate parameterization to achieve a reasonable approximation of the tranche´s risk profile. We consider the tranche as a “virtual” borrower or bond for which a single-factor model holds. Then, the correlation parameter is calculated via a non-linear optimization. This “bond representation” allows to approximate the risk profile (expressed by the EL profile) using a single-factor model and to express the dependence on the systematic risk factor via the corresponding asset correlation. It turns out that the resulting asset correlation is many times higher than that of straight bonds. Then, the Merton type valuation model for the corresponding bond representations is applied for valuation of the CDO tranches. Using a sample CDO portfolio, some opportunities for “CDO arbitrage” are described where it is assumed that investors are guided solely by the tranches’ rating and ignore the increased systematic risk for pricing. In the next section we discuss how tranches with high systematic risk can be generated and how CDO arrangers can exploit this to their advantage. It comes as no surprise that precisely these types of structures featured in many of the CDOs issued prior to the outbreak of the financial crisis. --
    Keywords: Collateralized debt obligations (CDO),arbitrage CDOs,credit rating,expected loss profile,bond representation,systematic risk of CDO tranches,CDO pricing
    JEL: C13 G12 G24
    Date: 2009

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