nep-fmk New Economics Papers
on Financial Markets
Issue of 2010‒02‒20
nine papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Global financial architecture: Past and present arguments, advice, action By Ashima Goyal
  2. Rating agencies: an information privilege whose time has passed By Nicolas Véron
  3. Threshold Effect and Financial Intermediation in Economic Development By Augier, Laurent; Soedarmono, Wahyoe
  4. The interbank market after August 2007: what has changed, and why? By Paolo Angelini; Andrea Nobili; Maria Cristina Picillo
  5. Asset auctions, information and liquidity By Vives, Xavier
  6. Equity lending markets and ownership structure By Saffi, Pedro A.C.; Sturgess, Jason
  7. An Equity-Interest Rate Hybrid Model With Stochastic Volatility and the Interest Rate Smile By Grzelak, Lech; Oosterlee, Kees
  8. Seasoned Equity Offerings by Small and Medium-Sized Enterprises By Cécile Carpentier; Jean-François L'Her; Jean-Marc Suret
  9. Demographics and the Term Structure of Stock Market Risk By Carlo A. Favero; Andrea Tamoni

  1. By: Ashima Goyal (Indira Gandhi Institute of Development Research)
    Abstract: In the context of the formation of G-20, the paper points out the absence of reform in the global financial architecture (GFA) after the East Asian crisis, and assesses factors that can improve the chances of real reform this time. A factual assessment of various causes advanced for the global crisis, puts the main responsibility on lax regulation. Liquidity created by current account imbalances was tiny compared to endogenous amplification of liquidity in the financial sector. Emerging markets needed reserves as self-insurance in the face of volatile cross border flows. Even so global imbalances increase risk. The paper summarizes the Chimerica debate and the blocks that have stalled progress in resolving the issue. It argues that symmetric and balanced reform, at individual country and international level, is required to remove the blocks. Deeper governance reforms will make it feasible. Potential contributions of the G-20 are outlined. It is argued that India is a useful example of flexible but managed exchange rates that allowed market deepening and export growth.
    Keywords: Global Financial architecture, Crisis, G-20, Imbalances, Over-saving
    JEL: F02 F32 F33
    Date: 2009–06
  2. By: Nicolas Véron
    Abstract: Nicolas Véron argues rating agencies have failed the marketplace in the run-up to the crisis, as their risk assessment processes have been found wanting on a number of counts. It is not clear that conflicts of interests have been the root cause of this serious failure, even if such conflicts may have existed. More regulation of rating agencies will not be a sufficient response to the challenge posed by the agencies recent failings, and carries risks of its own. What is needed is a deeper change in the structure of the market for financial risk assessment services.
    Date: 2009–02
  3. By: Augier, Laurent; Soedarmono, Wahyoe
    Abstract: This paper analyzes the theoretical finance-growth nexus. Using the Neoclassical growth framework, we raise a new issue where our finance-growth nexus has multiple stationary states with threshold effect. Threshold effect prevents the economy to reach long-run steady state equilibrium of capital and hence financial economists in developing countries should be aware of such an impediment. We show that the development of banking sector should be more supported than financial market, since banking sector is better than financial market in order to reduce threshold effect and ensure the existence and uniqueness of a higher long-run steady state equilibrium of capital stock.
    Keywords: Threshold Effect; Financial Intermediation; Economic Growth; Developing Countries
    JEL: O16 C61 C62
    Date: 2010–02–05
  4. By: Paolo Angelini (Bank of Italy); Andrea Nobili (Bank of Italy); Maria Cristina Picillo (Bank of Italy)
    Abstract: The outbreak of the financial crisis coincided with a sharp increase of worldwide interbank interest rates. We analyze the micro and macroeconomic determinants of this phenomenon, finding that before August 2007 interbank rates were insensitive to borrower characteristics, whereas afterwards they became reactive to borrowers’ creditworthiness. At the same time, conditions for large borrowers became relatively more favorable, both before and after the failure of Lehman Brothers. This suggests that banks have become more discerning in their lending, a welcome change, but that moral hazard considerations related to the â€too big to fail†argument should remain a main concern for central banks.
    Keywords: Interbank markets, Spreads, Financial crisis
    JEL: E43 E52
    Date: 2009–10
  5. By: Vives, Xavier (IESE Business School)
    Abstract: A model is presented of a uniform price auction where bidders compete in demand schedules; the model allows for common and private values in the absence of exogenous noise. It is shown how private information yields more market power than the levels seen with full information. Results obtained here are broadly consistent with evidence from asset auctions, may help explain the response of central banks to the crisis and suggest potential improvements in the auction formats of asset auctions.
    Keywords: adverse selection; market power; reverse auctions; bid shading;
    JEL: D44 D82 E58 G14
    Date: 2009–12–03
  6. By: Saffi, Pedro A.C. (IESE Business School); Sturgess, Jason (McDonough School of Business)
    Abstract: Using proprietary data on equity lending supply, loan fees and quantities, we examine the link between institutional ownership structure and the market for equity lending and stock prices. We find that both total institutional ownership and ownership concentration (measured by the Herfindahl index, single largest holding and number of investors) are important determinants of equity lending supply and short sale constraints. More concentrated ownership structures increase short sale constraints (including loan fees, recall risk and arbitrage risk) and force arbitrageurs to decrease demand for equity borrowing and demand greater compensation for borrowing stock. The results suggest that the impact of institutional ownership structure in the equity lending market may create limits to arbitrage.
    Keywords: Equity lending markets; short selling; ownership structure; lending supply;
    JEL: G10 G11 G14 G18 G28 G32
    Date: 2009–11–09
  7. By: Grzelak, Lech; Oosterlee, Kees
    Abstract: We define an equity-interest rate hybrid model in which the equity part is driven by the Heston stochastic volatility [Hes93], and the interest rate (IR) is generated by the displaced-diffusion stochastic volatility Libor Market Model [AA02]. We assume a non-zero correlation between the main processes. By an appropriate change of measure the dimension of the corresponding pricing PDE can be greatly reduced. We place by a number of approximations the model in the class of affine processes [DPS00], for which we then provide the corresponding forward characteristic function. We discuss in detail the accuracy of the approximations and the efficient calibration. Finally, by experiments, we show the effect of the correlations and interest rate smile/skew on typical equity-interest rate hybrid product prices. For a whole strip of strikes this approximate hybrid model can be evaluated for equity plain vanilla options in just milliseconds.
    Keywords: hybrid models; Heston equity model; Libor Market Model with stochastic volatility; displaced diffusion; affine diffusion; fast calibration.
    JEL: G1 F3 G13
    Date: 2010–01–27
  8. By: Cécile Carpentier; Jean-François L'Her; Jean-Marc Suret
    Abstract: Most of the analyses of small firms’ decision to seek outside equity financing and the conditions thereof have concerned private firms. Knowledge of the risk and return of entrepreneurial ventures for outside investors is consequently limited. This paper attempts to fill this gap by examining the Canadian context, where small and medium-sized enterprises (SMEs) are allowed to list on a stock market. We analyze seasoned equity offerings launched by SMEs over the last decade. These public issuers can be considered low quality firms with poor operating performance. Managers issue equity before a large decrease in operating and stock market performance. Individual investors do not price the stocks correctly around the issue and incur significant negative returns in the years following the issue. This is particularly true for constrained issuers. We confirm that entrepreneurial outside equity attracts lemons, and that individual investors cannot invest wisely in emerging ventures. Probably as a consequence of individual investors’ lack of skill and rationality, the cost of outside equity financing of Canadian public SMEs is abnormally low. <P>La plupart des analyses de la décision et des conditions de financement des petites entreprises portent sur des entités privées. Le risque et le rendement que ces entreprises représentent pour les investisseurs sont donc très mal connus. Ce papier tente de combler cette lacune en utilisant le contexte canadien, où les petites et moyennes entreprises (PMEs) sont autorisées à s’introduire en bourse. Nous analysons les financements par fonds propres levés par ces PMEs au cours de la dernière décennie. Ces émetteurs peuvent être considérés comme des entreprises de faible qualité présentant une piètre performance opérationnelle. Les dirigeants émettent des actions juste avant une forte diminution de la performance comptable et boursière. Les investisseurs individuels n’évaluent pas correctement les actions au moment de l’émission et subissent des rendements négatifs significatifs au cours des années postérieures. Ceci est particulièrement vrai pour les émetteurs contraints financièrement. Nous confirmons que le marché du financement externe des PMEs attire des « citrons », et que les investisseurs individuels ne peuvent pas investir de façon avisée dans les entreprises en développement. Conséquence probable d’un manque d’expérience et de rationalité des investisseurs individuels, le coût des fonds propres externes est anormalement bas pour les PMEs inscrites en bourse au Canada.
    Keywords: financing decision, equity offerings, small business, long-run performance, cost of equity, financial constrain, décision de financement, financement par fonds propres, petites entreprises, coût des fonds propres, performance, contrainte financière
    JEL: G14 G32 L26
    Date: 2010–01–01
  9. By: Carlo A. Favero; Andrea Tamoni
    Abstract: The term structure of stock market risk depends on the predictability of stock market returns at different horizons. Intuitive reasoning, formal modeling and empirical evidence show that demographic trends are a slow-moving information variable, whose forecasting power is low at high frequency but becomes high at low frequencies, when the effect of the noisy component of stock market fluctuations disappears. We show that the forward solution of the dynamic dividend growth model does naturally progressively eliminate the noise component as the horizon increases. Direct regressions of returns at different horizon on the relevant predictors capture this feature of the model, while VAR based multiperiod iterated forecasts do not, as they are derived from a backward solution of a reduced form empirical model. The combination of direct regression with the use of demographic trends leads us to find a steeply downaward sloping term structure of stock market risk.
    Date: 2010

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