nep-fmk New Economics Papers
on Financial Markets
Issue of 2010‒12‒04
ten papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Co-movement of Stock Returns: Irrational or Driven by Fundamentals? By Stefan Erdorf; Nicolas Heinrichs
  2. Getting the Most out of Macroeconomic Information for Predicting Stock Returns and Volatility By Cem Cakmakli; Dick van Dijk
  3. Equity Risk Premium and Time Horizon : What do the U.S. Secular Data Say ? By Georges Prat
  4. Quoted Spreads and Trade Imbalance Dynamics in the European Treasury Bond Market By Guglielmo Maria Caporale; Alessandro Girardi; Paolo Paesani
  5. Financial Crises in Efficient Markets: How Fundamentalists Fuel Volatility By Ariane Szafarz
  6. The Hartman-Watson Distribution revisited: Asymptotics for Pricing Asian Options By Stefan Gerhold
  7. Government Intervention and the CDS Market: A Look at the Market’s Response to Policy Announcements During the 2007-2009 Financial Crisis By Caitlin Ann Greatrex; Erick W. Rengifo
  8. A Diamond-Dybvig Model Without Bank Run: the Power of Signaling By Kiss, Hubert Janos
  9. Case Study of Three German Banks Stuck in the Subprime Crisis By Peixin Zhang
  10. Does a banking relationship help a firm on the syndicated loans market in a time of financial crisis? By Herve Alexandre; Karima Bouaiss; Catherine Refait-Alexandre

  1. By: Stefan Erdorf (Graduate School of Risk Management, University of Cologne); Nicolas Heinrichs (Graduate School of Risk Management, University of Cologne)
    Abstract: The co-movement of stocks and of fundamentals changes across the business cycle. Empirical studies have shown that the correlation of stock returns is stronger in crisis. We show that the correlation of fundamentals is the highest during crisis using a large sample of quarterly firm revenues aggregated to industry data from 1969 to 2009. The results of our study indicate that the co-movement of stocks is driven by the co-movement of fundamentals and is not an irrational reaction of markets. Both correlations between industries and the aggregate market and correlations between earnings confirm our findings.
    Keywords: correlation, business cycle, fundamentals, revenues, earnings, co-movement of stock returns, crisis, bootstrap, permutation test, industry classification
    JEL: C12 E32 G11 M49
    Date: 2010–07
  2. By: Cem Cakmakli (Erasmus University Rotterdam); Dick van Dijk (Erasmus Universiteit Rotterdam)
    Abstract: This paper documents that factors extracted from a large set of macroeconomic variables bear useful information for predicting monthly US excess stock returns and volatility over the period 1980-2005. Factor-augmented predictive regression models improve upon both benchmark models that only include valuation ratios and interest rate related variables, and possibly individual macro variables, as well as the historical average excess return. The improvements in out-of-sample forecast accuracy are both statistically and economically significant. The factor-augmented predictive regressions have superior market timing ability and volatility timing ability, while a mean-variance investor would be willing to pay an annual performance fee of several hundreds of basis points to switch from the predictions offered by the benchmark models to those of the factor-augmented models. An important reason for the superior performance of the factor-augmented predictive regressions is the stability of their forecast accuracy, whereas the benchmark models suffer from a forecast breakdown during the 1990s.
    Keywords: return predictability; model uncertainty; dynamic factor models; variable selection
    JEL: C22 C53 G11 G12
    Date: 2010–11–22
  3. By: Georges Prat
    Abstract: An ex-ante equity risk premium is the difference between the expected return of a risky asset at time t for a given future time horizon and an equivalent maturity risk-free interest rate. Using annual US secular data from 1871 to 2008, this study aims to model simultaneously the measures and the explanations of ex-ante equity risk premia for two polar horizons: the one period ahead horizon (i.e. the "short term" premium) and the infinite time horizon (i.e. the "long term" premium). Expectations being represented by traditional adaptive processes, large disparities in the dynamics of the two premia are evidenced. According to the conditional CAPM, each premium is at time t explained by the product of the price of risk by the expected variance of returns, these two magnitudes being horizon dependant. The expected variances depend on the past values of the centered squared returns (we found 5 and 8 years for the one year and the infinite horizon, respectively). For each horizon, the price of risk is determined by a spread of interest rates capturing economic factors of uncertainty and by an unobservable variable determined according to the kalman filter methodology (i.e. a state variable). The state variables are supposed to capture the influence of hidden variables and of non directly measurable psychological effects. The model gives a valuable representation of the "short term" and "long term" premia.
    Keywords: equity risk premium, time horizon
    JEL: D81 D84 E44 G11 G12
    Date: 2010
  4. By: Guglielmo Maria Caporale; Alessandro Girardi; Paolo Paesani
    Abstract: Using high-frequency transaction data for the three largest European markets (France, Germany and Italy), this paper documents the existence of an asymmetric relationship between market liquidity and trading imbalances: when quoted spreads rise (fall) and liquidity falls (increases) buy (sell) orders tend to prevail. Risk-averse market-makers, with inventory-depletion risk being their main concern, tend to quote wider (narrower) spreads when they think bond appreciation is more (less) likely to occur. It is also found that the probability of being in a specific regime is related to observable bond market characteristics, stock market volatility, macroeconomic releases and liquidity management operations of the monetary authorities.
    Keywords: Liquidity, trading activity, Treasury bond market, Europe, commonality
    JEL: G1 G15 C32 C33
    Date: 2010
  5. By: Ariane Szafarz
    Abstract: When a financial crisis breaks out, speculators typically get the blame whereas fundamentalists are presented as the safeguard against excessive volatility. This paper proposes an asset pricing model where two types of rational traders coexist: short-term speculators and long-term fundamentalists, both sharing the same information set. In this framework, excess volatility not only exists, but is actually fueled by fundamental trading. Actually, efficient markets are more volatile with a few speculators than with many speculators. Regulators should therefore be aware that efforts to limit speculation might, surprisingly, end up increasing volatility.
    Keywords: Efficient Markets; Speculators; Fundamentalists; Crises; Asset Pricing; Rational Expectations; Speculative Bubbles; Liquidity
    JEL: G14 G12 D84
    Date: 2010–11
  6. By: Stefan Gerhold
    Abstract: Barrieu, Rouault, and Yor [J. Appl. Probab. 41 (2004)] determined asymptotics for the logarithm of the distribution function of the Hartman-Watson distribution. We determine the asymptotics of the density. This refinement can be applied to the pricing of Asian options in the Black-Scholes model.
    Date: 2010–11
  7. By: Caitlin Ann Greatrex (Iona College, Department of Economics); Erick W. Rengifo (Fordham University, Department of Economics)
    Abstract: This paper adds to the literature on the financial markets’ reaction to government interventions during the 2007-2009 financial crisis by analyzing the response of US firms’ credit default swap spreads to key government actions. We find that the government measures taken to stabilize both the financial sector and the overall economy were generally well-received by CDS market participants, reducing perceived credit risk across a broad cross-section of firms. Financial firms responded most favorably to financial sector policies and interest rate cuts, with announcement date abnormal CDS spread changes of -5 and -2 percent, respectively. Non-financial firms responded most favorably to conventional fiscal and monetary policy tools with spread reductions of approximately one percent upon announcement of these measures. In a cross-sectional regression analysis, we find that size, recent performance, profitability, and stock returns are key factors in explaining the financial sectors response to government actions.
    JEL: G14 G18 G28
    Date: 2010
  8. By: Kiss, Hubert Janos (Departamento de Análisis Económico (Teoría e Historia Económica). Universidad Autónoma de Madrid.)
    Abstract: This paper introduces the possibility of signaling into a finite-depositor version of the Diamond-Dybvig model. More precisely, the decision to keep the funds in the bank is assumed to be unobservable,but depositors are allowed to make it observable by signaling, at a cost. Depositors decide consecutively whether to withdraw their funds or continue holding balances in the bank, and they choose if they want to signal the latter decision. If the cost of signaling is moderate, then bank runs do not occur. Moreover,no signals are made, so the unconstrained-efficient allocation is implemented without any costs.
    Keywords: bank run; sequential game; signaling; iterated deletion of strictly dominated strategies; coordination.
    JEL: C72 D82 G21
    Date: 2010–11
  9. By: Peixin Zhang
    Abstract: This paper is aimed at finding banks' destabilizing behaviors that explain why the impact of the crisis is so serious in the banking system. By comparing three German banks stuck in the crisis, I find that: I) the leverage is a common destabilizing factor and, ii) the banks were highly interconnected to other financial institutions and had a large maturity mismatch were more seriously affected by the crisis.
    Keywords: Systemic crisis, Leverage, Maturity mismatch, Banking regulation
    JEL: G14 G21 G28
    Date: 2010
  10. By: Herve Alexandre (DRM - Dauphine Recherches en Management - CNRS : UMR7088 - Université Paris Dauphine - Paris IX); Karima Bouaiss (CERMAT - Centre d'Etudes et de Recherche en MAnagement de Touraine - IAE de Tours); Catherine Refait-Alexandre (CRESE - Centre de REcherches sur les Stratégies Economiques - Université de Franche-Comté : EA)
    Abstract: The volume of credit granted in the form of syndicated loans saw a marked downturn in 2008. This article seeks to understand how certain firms were nonetheless able to benefit from larger facilities or a lower interest rate than others. Using a sample of syndicated loans issued in 2008 in North America and Europe, and records of syndicated loans since 2003, we show that firms that had developed a relationship with an investment bank obtained a lower spread, but did not benefit from greater loan facilities or longer maturities.
    Keywords: syndicated loans, banking relationship, credit rationing
    Date: 2010–09–15

This nep-fmk issue is ©2010 by Kwang Soo Cheong. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.