New Economics Papers
on Financial Markets
Issue of 2010‒09‒25
six papers chosen by

  1. Price Jumps in Visegrad Country Stock Markets: An Empirical Analysis By Jan Novotny
  2. Tick size and price diffusion By Gabriele La Spada; J. Doyne Farmer; Fabrizio Lillo
  3. Level Shifts in Volatility and the Implied-Realized Volatility Relation By Bent Jesper Christensen; Paolo Santucci de Magistris
  4. The Economic Costs of US Stock Mispricing By G. Menzies; R. Bird; P. Dixon; M. Rimmer
  5. TBA trading and liquidity in the agency MBS market By James Vickery; Joshua Wright
  6. Driven by the Markets? ECB Sovereign Bond Purchases and the Securities Markets Programme By Ansgar Belke

  1. By: Jan Novotny
    Abstract: I empirically study price jumps using high frequency data comprising 5-, 10-, 15- and 30-minute market data on the main indices from the Prague, Warsaw, Budapest and Frankfurt Stock Exchanges for June 2003 to the end of 2008. I use two definitions of price jumps: the price jump index and normalized returns. First, I analyze the distribution of returns to support the presence of jumps. Second, I find that the distributions of the price jump indicators employed are significantly different for positive moves compared with negative moves in all the markets studied. In addition, the comparison of jump distributions across different frequencies and markets suggests a possible relationship with market micro-structure as well as with the composition of investors. In particular, at the Prague Stock Exchange, the lower the frequency, the lower the number of extreme jumps, but this is not so at the other markets. Last but not least, I show that the recent financial crisis caused an overall increase in volatility. However, this was not translated into an increase in the absolute number of jumps.
    Keywords: financial markets; Visegrad region; price jumps.
    JEL: G15 P59
    Date: 2010–08
  2. By: Gabriele La Spada; J. Doyne Farmer; Fabrizio Lillo
    Abstract: A tick size is the smallest increment of a security price. Tick size can affect security price in direct and indirect ways. It is clear that at the shortest time scale on which individual orders are placed the tick size has a major role which affects where limit orders can be placed, the bid-ask spread, etc. This is the realm of market microstructure and in fact there is a vast literature on the role of tick size on market microstructure. However, tick size can also affect price properties at longer time scales, and relatively less is known about the effect of tick size on the statistical properties of prices. The present paper is divided in two parts. In the first we review the effect of tick size change on the market microstructure and the diffusion properties of prices. The second part presents original results obtained by investigating the tick size changes occurring at the New York Stock Exchange (NYSE). We show that tick size change has three effects on price diffusion. First, as already shown in the literature, tick size affects price return distribution at an aggregate time scale. Second, reducing the tick size typically leads to an increase of volatility clustering. We give a possible mechanistic explanation for this effect, but clearly more investigation is needed to understand the origin of this relation. Third, we explicitly show that the ability of the subordination hypothesis in explaining fat tails of returns and volatility clustering is strongly dependent on tick size. While for large tick sizes the subordination hypothesis has significant explanatory power, for small tick sizes we show that subordination is not the main driver of these two important stylized facts of financial market.
    Date: 2010–09
  3. By: Bent Jesper Christensen (Aarhus University and CREATES); Paolo Santucci de Magistris (University of Pavia and CREATES)
    Abstract: We propose a simple model in which realized stock market return volatility and implied volatility backed out of option prices are subject to common level shifts corresponding to movements between bull and bear markets. The model is estimated using the Kalman filter in a generalization to the multivariate case of the univariate level shift technique by Lu and Perron (2008). An application to the S&P500 index and a simulation experiment show that the recently documented empirical properties of strong persistence in volatility and forecastability of future realized volatility from current implied volatility, which have been interpreted as long memory (or fractional integration) in volatility and fractional cointegration between implied and realized volatility, are accounted for by occasional common level shifts.
    Keywords: Common level shifts, fractional cointegration, fractional VECM, implied volatility, long memory, options, realized volatility.
    JEL: C32 G13 G14
    Date: 2010–09–09
  4. By: G. Menzies; R. Bird; P. Dixon; M. Rimmer
    Abstract: The USAGE model for the United States is used to quantify economic costs due to stock mispricing, made operational by shocking Tobin's q. The simulations quantify a potentially large impact even in the most favorable environment, where export demand holds up, and, the dollar is pro cyclical. A two year investment boom in two sectors increases consumption by a Net Present Value (NPV) amount of nearly one per cent, due to a positive investment externality onto the US terms of trade. If the investment is wasted, however, the consumption loss is nearly one half of a per cent. A 5 year 'capital strike' across the whole economy subsequent to the boom - mimicking financial distress from a burst bubble - shaves around 10 per cent off consumption.
    Keywords: Financial crises, exchange rates, macroeconomic modeling, stock market
    JEL: C50 F41
    Date: 2010–07
  5. By: James Vickery; Joshua Wright
    Abstract: Most mortgages in the United States are securitized through the agency mortgage-backed-securities (MBS) market. These securities are generally traded on a “to-be-announced,” or TBA, basis. This trading convention significantly improves agency MBS liquidity, leading to lower borrowing costs for households. Evaluation of potential reforms to the U.S. housing finance system should take into account the effects of those reforms on the operation of the TBA market.
    Keywords: Mortgages ; Mortgage-backed securities ; Liquidity (Economics) ; Housing - Finance ; Financial market regulatory reform
    Date: 2010
  6. By: Ansgar Belke
    Abstract: After the dramatic rescue package for the euro area, the governing council of the European Central Bank decided to purchase European government bonds – to ensure an “orderly monetary policy transmission mechanism”. Many observers argued that, by bond purchases, national fi scal policies could from now on dominate the common monetary policy. This note argues that they are quite right. The ECB has indeed become more dependent in political and fi nancial terms. The ECB has decided to sterilise its bond purchases – compensating those purchases through sales of other bonds or money market instruments to keep the overall money supply unaff ected. This is to counter accusations that the ECB is monetizing government debt. This note addresses how eff ective these sterilisation policies are. One problem inherent in the sterilization approach is that it reshuffl es only the liability side of the ECB’s balance sheet. It is not well-suited to either diminish the bloated ECB balance sheet or to remove the potentially toxic covered or sovereign bonds from it. In addition, the intake of potentially toxic assets as collateral and by outright purchases in the central bank balance sheet artifi cially keeps the asset prices up and does not prevent the (quite intransparent) risk transfer from one group of countries to another to occur. Finally, sterilization takes place in a setting of still ultra-lax monetary policies, i.e. of new liquidity-enhancing operations with unlimited allotment, and, hence, does not appear to be overly irrelevant. A credible strategy to deal with the fi nancial crisis should deal primarily with the asset side of the ECB balance sheet. This note also addresses negative side eff ects of the SMP such as, for instance, the fact that the ECB is currently curbing real returns at the bond markets through its bond purchases. Currently, the real return of Spanish, Portuguese and Italian bonds only amounts to 3 to 3.5 percent. This is almost certainly not enough to attract private capital these countries are heavily dependent on. The most worrisome aspect is that the euro area has stumbled into a perpetuation of unconventional monetary policies by the execution of the SMP. Of course, the intentions are to bail out banks (but not just banks) and to support governments with issuance. What is diffi cult to see at the moment is how, once started, it will be able to stop. Finally, the ECB has been too silent about the following key questions which tends to frighten potential private investors in euro area sovereign bonds: What exactly is the composition of the sovereign bonds the ECB is buying? Which criteria are applied to select bonds to purchase? How is the ECB’s bond purchase strategy characterized in cases and periods of primary issuance? How long is the SMP going to last and what amounts may be spent?
    Keywords: accountability; bail-out; bond purchases; central bank independence; insolvency risk; Securities Markets Programme; transparency
    JEL: G32 E42 E51 E58 E63
    Date: 2010–06

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