nep-fmk New Economics Papers
on Financial Markets
Issue of 2011‒01‒03
four papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. How to regulate a financial market? The impact of the 1893-1898 regulatory reforms on the Paris Bourse By Pierre-Cyrille Hautcoeur; Amir Rezaee; Angelo Riva
  2. Did the Market Signal Impending Problems at Northern Rock? An Analysis of Four Financial Instruments By Paul Hamalainen; Adrian Pop; Max Hall; Barry Howcroft
  3. Predicting Financial Distress in a High-Stress Financial World: The Role of Option Prices as Bank Risk Metrics By Jérôme Coffinet; Adrian Pop; Muriel Tiesset
  4. Realized volatility and overnight returns By Ahoniemi, Katja; Lanne, Markku

  1. By: Pierre-Cyrille Hautcoeur (EHESS - Ecole des hautes études en sciences sociales - Ministère de l'Enseignement Supérieur et de la Recherche Scientifique, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - Ecole des Ponts ParisTech - Ecole Normale Supérieure de Paris - ENS Paris); Amir Rezaee (LEO - Laboratoire d'économie d'Orleans - CNRS : UMR6221 - Université d'Orléans, EDHEC - Edhec); Angelo Riva (IREBS - Institut de recherche de l'European Business School - European Business School, IDHE - Institutions et Dynamiques Historiques de l'Economie - CNRS : UMR8533 - Université Panthéon-Sorbonne - Paris I - Université Paris VIII Vincennes-Saint Denis - Université de Paris X - Nanterre - École normale supérieure de Cachan - ENS Cachan)
    Abstract: Theoretical and historical experience suggests a financial centre may either include a single, consolidated and loosely regulated stock exchange attracting all intermediaries and actors, or a variety of exchanges going from strictly regulated to completely unregulated and adapted to the needs of different categories of intermediaries, investors and issuers. Choosing between these two solutions is uneasy because few substantial changes occur at this "meta-regulatory" level. The history of the Paris exchanges provides a good example, since two legal changes in opposite directions occurred in the late 19th century, when Paris was the second financial centre in the world. In 1893, a law threatened the existing two-exchanges equilibrium by diminishing the advantages of the more regulated exchange; in 1898, another law brought them back. We analyse the impact of these two changes on the competition between the exchanges in terms of securities listed, traded volumes and spreads. We conclude competition among exchanges is a delicate matter and efficiency is not always where one would think.
    Keywords: Paris Stock exchange ; microstructure ; monopoly ; regulation
    Date: 2010–01–01
  2. By: Paul Hamalainen (Essex Business School - University of Essex); Adrian Pop (LEMNA - Laboratoire d'économie et de management de Nantes Atlantique - Université de Nantes : EA4272); Max Hall (Department of Economics - Loughborough University); Barry Howcroft (The Business School - Loughborough University)
    Abstract: The academic literature has regularly argued that market discipline can support regulatory authority mechanisms in ensuring banking sector stability. This includes, amongst other things, using forward-looking market prices to identify those credit institutions that are most at risk of failure. The paper's key aim is to analyse whether market investors signalled potential problems at Northern Rock in advance of the bank announcing that it had negotiated emergency lending facilities at the Bank of England in September 2007. A further aim of the paper is to examine the signalling qualities of four financial market instruments (credit default swap spreads, subordinated debt spreads, implied volatility from options prices and equity measures of bank risk) so as to explore both the relative and individual qualities of each. Therefore, the paper's findings contribute to the market discipline literature on using market data to identify bank risk-taking and enhancing supervisory monitoring. Our analysis suggests that private market participants did signal impending financial problems at Northern Rock. These findings lend some empirical support to proposals for the supervisory authorities to use market information more extensively to improve the identification of troubled banks. The paper identifies equities as providing the timeliest and clearest signals of bank condition, whilst structural factors appear to hamper the signalling qualities of subordinated debt spreads and credit default swap spreads. The paper also introduces idiosyncratic implied volatility as a potentially useful early warning metric for supervisory authorities to observe.
    Keywords: Bank regulation ; bank failures ; market discipline ; early-warning signals
    Date: 2010–12–17
  3. By: Jérôme Coffinet (Banque de France - Banque de France); Adrian Pop (LEMNA - Laboratoire d'économie et de management de Nantes Atlantique - Université de Nantes : EA4272); Muriel Tiesset (Banque de France - Banque de France)
    Abstract: The current financial crisis offers a unique opportunity to investigate the leading properties of market indicators in a stressed environment and their usefulness from a banking supervision perspective. One pool of relevant information that has been little explored in the empirical literature is the market for bank's exchange-traded option contracts. In this paper, we first extract implied volatility indicators from the prices of the most actively traded option contracts on financial firms' equity. We then examine empirically their ability to predict financial distress by applying survival analysis techniques to a sample of large US financial firms. We find that market indicators extracted from option prices significantly explain the survival time of troubled financial firms and do a better job in predicting financial distress than other time-varying covariates typically included in bank failure models. Overall, both accounting information and option prices contain useful information of subsequent financial problems and, more importantly, the combination produces good forecasts in a high-stress financial world, full of doubts and uncertainties.
    Keywords: Financial distress ; Financial system oversight ; Market discipline ; Options ; Implied volatility ; Survival analysis
    Date: 2010–10–01
  4. By: Ahoniemi, Katja (Aalto University School of Economics); Lanne, Markku (University of Helsinki)
    Abstract: No consensus has emerged on how to deal with overnight returns when calculating realized volatility in markets where trading does not take place 24 hours a day. This paper explores several common volatility applications, investigating how the chosen treatment of overnight returns affects the results. For example, the selection of the best volatility forecasting model depends on the way overnight returns are incorporated into realized volatility. The evidence favours weighted estimators over those that have been more commonly used in the existing literature. The definition of overnight returns is particularly challenging for the S&P 500 index, and we propose two alternative measures for its overnight return.
    Keywords: realized volatility; forecasting
    JEL: C14 C22 C52
    Date: 2010–12–08

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