New Economics Papers
on Financial Markets
Issue of 2011‒10‒09
seven papers chosen by

  1. Equity Prices and Equity Flows: Testing Theory of the Information-Efficiency Tradeoff By Assaf Razin; Anuk Serechetapongse
  2. Pricing stocks with yardsticks and sentiments By Sebast\ian Mart\inez Bustos; Jorgen Vitting Andersen; Michel Miniconi; Andrzej Nowak; Magdalena Roszczynska-Kurasinska; David Bree
  3. Asset Price Developments in an Emerging Stock Market: The Case of Mauritius By Sunil K. Bundoo
  4. Some Stylized Facts of Returns in the Foreign Exchange and Stock Markets in Peru By Alberto Humala; Gabriel Rodriguez
  5. Securitization and moral hazard: evidence from credit score cutoff rules By Ryan Bubb; Alex Kaufman
  6. An Estimation of the Inside Bank Premium By NEMOTO Tadanobu; OGURA Yoshiaki; WATANABE Wako
  7. Using Bank Mergers and Acquisitions to Understand Lending Relationships By Hetland, Ove Rein; Mjøs, Aksel

  1. By: Assaf Razin (Cornell University and Tel Aviv University and Hong Kong Institute for Monetary Research); Anuk Serechetapongse (Cornell University)
    Abstract: The paper tests three hypotheses concerning foreign equity investment in the presence of liquidity risk. First, the FDI-to-FPI price differential is negatively related to liquidity risk (the "Price Discount Hypothesis"). The idea is that market participants do not know whether the FDI investor liquidates a firm because of an idiosyncratic liquidity shock, or because, as an informed investor, the firm is hit by a productivity shock. Second, the FDI-to-FPI composition of foreign equity investment skews towards FPI if investors are expected to experience a liquidity shortage in the future (the "Equity-Composition Hypothesis"). The idea is that because direct investments are more costly to liquidate, due to the price discount, the more severe is the expected liquidity shock, the smaller is the FDI-to-FPI ratio. Third, the FDI-to-FPI composition of foreign equity flows skews towards FDI, the larger are past FDI-to-FPI stocks (the "Strategic Complementarity Hypothesis"). The idea is that high liquidity needs investors generate a positive information-externality for low liquidity needs investors among investors who choose FDI, and further increases in the number of FDI investors comes from mainly high liquidity needs investors. Such an increase reinforces the information externality, thereby lowering the FDI-to-FPI price discount, creating further incentives for investors to choose FDI. The paper brings these hypotheses to country level data consisting of a large set of developed and developing countries over the period 1970 to 2004. The evidence gives strong support to the hypotheses. To test the hypotheses, we apply also a dynamic panel model to examine the variation of FPI relative to FDI for source and host countries from 1985 to 2004. Country-wide sales of external assets are used as a proxy for liquidity problems. We estimate the determinants of liquidity problems, and then test the effect of expected liquidity problems on stock prices, the ratio of FPI to FDI and gross flows of FDI and FPI. We find strong support for the hypotheses: greater expected liquidity problems increase the price discount, have a significant positive effect on gross flows of FPI, negative effect on gross flows of FPI, and positive effect on the ratio between FPI and FDI.
    Date: 2011–09
  2. By: Sebast\ian Mart\inez Bustos; Jorgen Vitting Andersen; Michel Miniconi; Andrzej Nowak; Magdalena Roszczynska-Kurasinska; David Bree
    Abstract: Human decision making by professionals trading daily in the stock market can be a daunting task. It includes decisions on whether to keep on investing or to exit a market subject to huge price swings, and how to price in news or rumors attributed to a specific stock. The question then arises how professional traders, who specialize in daily buying and selling large amounts of a given stock, know how to properly price a given stock on a given day? Here we introduce the idea that people use heuristics, or "rules of thumb", in terms of "yard sticks" from the performance of the other stocks in a stock index. The under- /over-performance with respect to such a yard stick then signifies a general negative/positive sentiment of the market participants towards a given stock. Using empirical data of the Dow Jones Industrial Average, stocks are shown to have daily performances with a clear tendency to cluster around the measures introduced by the yard sticks. We illustrate how sentiments, most likely due to insider information, can influence the performance of a given stock over period of months, and in one case years.
    Date: 2011–09
  3. By: Sunil K. Bundoo
    Abstract: The Stock Exchange of Mauritius (SEM) has been in operation for more than 15 years. As at December 2004, there were 40 companies listed on the official market. The main objectives of this study were to analyse the risk return characteristics of all the companies listed on the SEM in terms of both total risk and systematic risk; to estimate time-varying betas; to investigate the existence of the size and book-to-market equity effects on the SEM and finally to augment the Fama and French (1993) three-factor model, by taking into account the time variation in betas. The period of study was January 1997 to June 2003 and using monthly returns. The study found out that CAPM stationary betas are different from betas corrected for thin trading. It is therefore crucial to take thin trading into account when estimating systematic risk for markets characterized by thin trading. Time-varying betas are different from stationary betas and the result supports the hypothesis that the SEM behaves like a small market capitalization index. The Fama and French three-factor model holds for the SEM. In other words, both a size effect and a book-to-market equity effect are present on the SEM. The augmented Fama and French model shows that the time variation in betas is priced, but the size and book-to-market equity effects are still statistically significant. The FF model is therefore robust after taking into account the time-variation in beta. However, the results might be sample specific. The test must be extended across other stock exchanges.
    Date: 2011–01
  4. By: Alberto Humala; Gabriel Rodriguez (Departamento de Economía - Pontificia Universidad Católica del Perú)
    Abstract: Some stylized facts for foreign exchange and stock market returns are explored using statistical methods. Formal statistics for testing presence of autocorrelation, asymmetry, and other deviations from normality are applied to these ?nancial returns. Dynamic correlations and di¤erent kernel estimations and approximations of the empirical distributions are also under scrutiny. Furthermore, dynamic analysis of mean, standard deviation, skewness and kurtosis are also performed to evaluate time-varying properties in return distributions. Main results reveal di¤erent sources and types of non-normality in the return distributions in both markets. Left fat tails, excess kurtosis, return clustering and unconditional time-varying moments show important deviations from normal- ity. Identi?able volatility cycles in both forex and stock markets are associated to common macro ?nancial uncertainty events.
    Keywords: Non-Normal Distributions, Stock Market Returns, Foreign Exchage, Market Returns
    JEL: C16 E44 F31 G10
    Date: 2011
  5. By: Ryan Bubb; Alex Kaufman
    Abstract: Mortgage originators use credit score cutoff rules to determine how carefully to screen loan applicants. Recent research has hypothesized that these cutoff rules result from a securitization rule of thumb. Under this theory, an observed jump in defaults at the cutoff would imply that securitization led to lax screening. We argue instead that originators adopted credit score cutoff rules in response to underwriting guidelines from Fannie Mae and Freddie Mac and offer a simple model that rationalizes such an origination rule of thumb. Under this alternative theory, jumps in default are not evidence that securitization caused lax screening. We examine loan-level data and find that the evidence is inconsistent with the securitization rule-of-thumb theory but consistent with the origination rule-of-thumb theory. There are jumps in the number of loans and in their default rate at credit score cutoffs in the absence of corresponding jumps in the securitization rate. We conclude that credit score cutoff rules provide evidence that large securitizers were to some extent able to regulate originators' screening behavior.
    Keywords: Mortgage loans ; Credit scoring systems
    Date: 2011
  6. By: NEMOTO Tadanobu; OGURA Yoshiaki; WATANABE Wako
    Abstract: This paper is an empirical examination of the existence of the inside bank premium arising from relationship banking, which is predicted in the extant theoretical models. These models predict that the contracted interest rate of a loan extended by an inside bank when there exist asymmetries between the inside bank and outside banks, such as the information advantage of the inside bank or the implicit insurance and other borrower-specific services exclusively provided by the inside bank, is higher than that without such asymmetries. Our statistical estimations are based on the dataset collected through the survey for small and medium-sized firms in Japan, which were designed to contain the questions about a firm's loan application process, and the agreed-upon loan terms that are crucial to our tests. Our estimations show that such an inside bank premium is 30-50 basis points on average for short-term loans. This is economically significant for the median short-term interest rate of 1.9 %. The subsample regressions show that this premium is more likely to come from the implicit insurance and that this premium is more significant for smaller inside banks in more competitive loan markets.
    Date: 2011–09
  7. By: Hetland, Ove Rein (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration); Mjøs, Aksel (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)
    Abstract: We study how firm-bank lending relationships affect firms' access to and terms of credit. We use bank mergers and acquisitions (M&As) as exogenous events that affect lending relationships. Bank M&As lead to organisational changes at the involved banks, which may reduce the amount of soft information encompassed in the firm-bank relationship. Using a unique Norwegian dataset, which combines information on companies' bank accounts, annual accounts, bankruptcies, and bank M&As for the years 1997-2009, we find that domestic bank mergers increase interest rate margins by 0.24 percentage points for opaque small and medium sized rms, relative to less opaque firms. Since, due to information asymmetries, opaque firms are typically more dependent on bank lending relationships, our results indicate that these relationships are advantageous for such borrowers, and the destruction of a relationship during the merger process has adverse effects for the firm. Conversely, the results are not consistent with a lock-in effect due to an information monopoly by the relationship lender that on average increases a firm's borrowing costs over its life cycle. The results are robust to the inclusion of variables that control for eects of market competition.
    Keywords: Bank Mergers and Acquisitions; Lending Relationships
    JEL: G00 G30 G34
    Date: 2011–08–31

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