nep-fmk New Economics Papers
on Financial Markets
Issue of 2010‒04‒17
ten papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Collateralized Security Markets By John Geanakoplos; William R. Zame
  2. "Incentives in Hedge Funds" By Hitoshi Matsushima
  3. Incentives and Risk Sharing in a Stock Market Equilibrium By Martine Quinzii; Michael Magill; Erwin W. Diewert
  4. Dynamic Sources of Sovereign Bond Market Liquidity By Kucuk, Ugur N.
  5. Funding Liquidity Risk and Deviations from Interest-Rate Parity During the Financial Crisis of 2007-2009 By Cho-Hoi Hui; Hans Genberg; Tsz-Kin Chung
  6. The pricing of government-guaranteed bank bonds By Aviram Levy; Andrea Zaghini
  7. Emerging Market Local Currency Bond Market, Too Risky to Invest? By Küçük, Ugur N.
  8. The Reform of Tokyo Stock Exchange and Transparency By Hideaki Sakawa; Masato Ubukata
  9. Quadratic hedging in an incomplete market derived by an influent informed investor By Anne Eyraud-Loisel
  10. A model-free approach to delta hedging By Michel Fliess; Cédric Join

  1. By: John Geanakoplos; William R. Zame
    Date: 2010–04–06
  2. By: Hitoshi Matsushima (Faculty of Economics, University of Tokyo)
    Abstract: We investigate a game of delegated portfolio management such as hedge funds featuring risk-neutrality, hidden types, and hidden actions. We show that capital gain tax plays the decisive role in solving the incentive problem. We characterize the constrained optimal fee scheme and capital gain tax rate; the fee after taxation must be linear and affected by gains and losses in a low-powered and symmetric manner. We argue that high income tax incentivizes managers to select this scheme voluntarily. The equity stake suppresses the distortion caused by solvency.
    Date: 2010–02
  3. By: Martine Quinzii; Michael Magill; Erwin W. Diewert
    Abstract: Economists hold two opposing views of the stock market: one focuses on the negative effect on incentives of separating ownership and control, the other emphasizes its beneficial role for risk sharing. Using a generalization of Diamond''s model which incorporates the effect of entrepreneurial incentives, we show how these two views can be reconciled. We introduce the concept of a stock market equilibrium with rational competitive price perceptions (RCPP) and show that such and equilibrium leads to a constrained optimal trade-off between risk sharing and incentives. We give examples showing the difference between RCPP equilibria and the standard CAPM type equilibria of finance.
  4. By: Kucuk, Ugur N.
    Abstract: Using 482 US Dollar and Euro denominated bonds issued by 72 sovereigns, we examine the dynamic sources of time-series and cross-sectional variations in \textit{market-wide liquidity} of sovereign bonds as a novelty in the sovereign fixed income literature. Vector autoregression analysis shows that macroeconomic fundamentals and the financial market variables play a substantial role in the movements of aggregate liquidity throughout the whole sample period (1999-2010), although their effects are stronger during the financial crisis. Specifically, US industrial production growth rate and inflation rate have significant informative powers on the sovereign bond market liquidity. An increasing shock to the TED spread (the spread between 3-Month Libor and US T-bill), a measure of distrust in the banking system, has detrimental impact, while on the other side equity market performance is positively linked to market-wide bond liquidity. Furthermore, the direction of causality from the world financial and macroeconomic variables towards the aggregate bond market liquidity is confirmed by Granger causality tests. Finally, impulse response functions show that these relationships are persistent up to one-year forecast horizon.
    Keywords: Sovereign Bond Market; Aggregate Liquidity; Financial Markets
    JEL: G15 E44 E40 G10
    Date: 2009–12–31
  5. By: Cho-Hoi Hui (Research Department, Hong Kong Monetary Authority); Hans Genberg (Research Department, Hong Kong Monetary Authority); Tsz-Kin Chung (Research Department, Hong Kong Monetary Authority)
    Abstract: Significant deviations from covered interest parity were observed during the financial crisis of 2007-2009. This paper finds that before the failure of Lehman Brothers the market-wide funding liquidity risk was the main determinant of these deviations in terms of the premiums on swap-implied US dollar interest rates for the euro, British pound, Hong Kong dollar, Japanese yen, Singapore dollar and Swiss Franc. This suggests that the deviations can be explained by the existence and nature of liquidity constraints. After the Lehman default, both counterparty risk and funding liquidity risk in the European economies were the significant determinants of the positive deviations, while the tightened liquidity condition in the US dollar was the main driving factor of the negative deviations in the Hong Kong, Japan and Singapore markets. Federal Reserve Swap lines with other central banks eased the liquidity pressure and reduced the positive deviations in the European economies.
    Keywords: Sub-prime crisis, funding liquidity, covered interest parity, FX swaps
    JEL: F31 F32 F33
    Date: 2009–07
  6. By: Aviram Levy (Bank of Italy); Andrea Zaghini (Bank of Italy)
    Abstract: We examine the effects of the government guarantee schemes for bank bonds adopted in the aftermath of the Lehman Brothers demise to help banks retain access to wholesale funding. We describe the evolution and the pattern of bond issuance across countries to assess the effect of the schemes. Then we propose an econometric analysis of one striking feature of this new market, namely the significant “tiering” of the spreads paid by banks at issuance, finding that they mainly reflect the characteristics of the guarantor (credit risk, size of rescue measures, timeliness of repayments) and not those of the issuing bank or of the bond itself.
    Keywords: banks, corporate bonds, financial crisis, government guarantees
    JEL: G12 G18 G21 G28 G32
    Date: 2010–03
  7. By: Küçük, Ugur N.
    Abstract: Over the last decade emerging market (EM) sovereign debt has become a firmly established strategic asset class. Besides Dollar-denominated debt, local currency emerging market debt has also been developing to become an attractive and complementary investment asset class. EM countries have been successful to reduce currency mismatches and maturity problems by implementing sound fiscal and monetary policies. Analyzing the period from 2002 to July 2009, we show that the local currency debt provides significant additional alpha and diversification to traditional bond portfolios. In particular, first, EM local currency bond returns are less correlated to the US stock market, treasury and high-yield bond markets, and global risk premia compared to the a case of EM equity and Dollar-denominated bond markets. Second, we document that yields and excess returns on local currency debt depend largely on expected depreciation of the exchange rate against Dollar, while excess returns on Dollar-denominated EM debt are for the most part compensation for bearing the global risk. Third, we report that EM sovereign local currency bond returns beat other emerging market and mature market asset classes by providing higher risk adjusted excess returns and diversification. We believe that our results will have important policy implications not only for international investors but also for the EM governments. We suggest that the development of local currency bond markets in EM countries could contribute to global financial stability by reducing currency mismatches and reliance on foreign currency debt, which in turn is linked to growth and poverty reduction.
    Keywords: Sovereign Bond Market; Local Currency Bonds; Emerging Markets; Bond Portfolio; Excess Returns
    JEL: G1 G11 G15
    Date: 2009–08–21
  8. By: Hideaki Sakawa; Masato Ubukata
    JEL: G14 G15 G18
    Date: 2010–03
  9. By: Anne Eyraud-Loisel (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429)
    Abstract: In this paper a model with an influent and informed investor is presented. The studied problem is the point of view of a non informed agent hedging an option in this influenced and informed market. Her lack of information makes the market incomplete to the non informed agent. The obtained results, by means of Malliavin calculus and Clark-Ocone Formula, as well as Filtering Theory are the expressions and a comparison between the strategy of the non informed trader, and the strategy of the informed agent. An expression of the residual risk a non informed trader keeps by detaining an option in this influenced and informed market is derived using a quadratic approach of hedging in incomplete market. Finally, the analysis leads to a measure of the lack of information that makes the incompleteness of the market. The financial interpretation is explained throughout the theoretical analysis, together with an example of such influenced informed model.
    Keywords: Enlargement of filtration; FBSDE; quadratic hedging; risk minimization; insider trading; influent investor; asymmetric information; martingale representation; Clark-Ocone formula.
    Date: 2009–10–31
  10. By: Michel Fliess (LIX - Laboratoire d'informatique de l'école polytechnique - CNRS : UMR7161 - Polytechnique - X, INRIA Saclay - Ile de France - ALIEN - INRIA - Polytechnique - X - CNRS : UMR - Ecole Centrale de Lille); Cédric Join (INRIA Saclay - Ile de France - ALIEN - INRIA - Polytechnique - X - CNRS : UMR - Ecole Centrale de Lille, CRAN - Centre de recherche en automatique de Nancy - CNRS : UMR7039 - Université Henri Poincaré - Nancy I - Institut National Polytechnique de Lorraine - INPL)
    Abstract: Delta hedging is a tracking control design for a ``risk-free'' financial management. We utilize the existence of trends for financial time series (Fliess M., Join C.: A mathematical proof of the existence of trends in financial time series, Proc. Int. Conf. Systems Theory: Modelling, Analysis and Control, Fes, 2009. Online: in order to propose a model-free setting for delta hedging. It avoids most of the shortcomings encountered with the now classic Black-Scholes-Merton setting. Several convincing computer simulations are presented. Some of them are dealing with abrupt changes, i.e., jumps.
    Keywords: Delta hedging; trends; quick fluctuations; abrupt changes; jumps; tracking control; model-free control
    Date: 2010

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