New Economics Papers
on Financial Markets
Issue of 2012‒09‒03
six papers chosen by

  1. The Devil's in the Tail: Residential Mortgage Finance and the U.S. Treasury By W. Scott Frame; Larry D. Wall; Lawrence J. White
  2. State-dependent Momentum in International Stock Markets By Dirk G Baur; Thomas Dimpfl
  3. Bond Ratings Matter: Evidence from the Lehman Brothers Index Rating Redefinition By Chen, Zhihua; Lookman, Aziz; Schürhoff, Norman; Seppi, Duane J
  4. Investment horizon dependent CAPM: Adjusting beta for long-term dependence By Carlos León; Karen Leiton; Alejandro Reveiz
  5. An Empirical Analysis of Australian Gold Mining Firms By Dirk G Baur
  6. Animal Spirits in the Euro Area Sovereign CDS Market By Blommestein, Hans J.; Eijffinger, Sylvester C W; Qian, Zongxin

  1. By: W. Scott Frame; Larry D. Wall; Lawrence J. White
    Date: 2012
  2. By: Dirk G Baur (Finance Discipline Group, UTS Business School, University of Technology, Sydney); Thomas Dimpfl (University of Tubingen)
    Abstract: We estimate quantile autoregression (QAR) models to analyze variations in the autoregressive coefficients of 55 international stock index returns and demonstrate that it is important to allow the autoregressive parameters to vary with quantiles. The empirical results identify distinctively different patterns of autoregressive coefficients in the lower, central and upper quantiles of the distribution across all countries. More specifically, the study suggests that investors follow momentum strategies in lower quantiles or "bad states". We also demonstrate that the quantile autoregression estimates can be used to test for asymmetric responses of the volatility.
    Keywords: quantile autoregression (QAR); return autocorrelation; investor behaviour; momentum; underreaction; financial crisis
    Date: 2012–08–01
  3. By: Chen, Zhihua; Lookman, Aziz; Schürhoff, Norman; Seppi, Duane J
    Abstract: The 2005 inclusion of Fitch ratings in the Lehman composite index ratings provides a quasi-natural experiment to identify rating-based market segmentation in the corporate bond market. Split-rated bonds with favorable Fitch rating that were mechanically upgraded to investment-grade status exhibit abnormal returns and order flows, whether or not they enter the Lehman investment-grade index itself. An asymmetric impact of favorable Fitch ratings on bonds around the HY-IG boundary whose index rating did not initially change suggests that mechanical changes in future index rating transition probabilities also affect bond pricing. Our results highlight the importance of rating-based industry norms and practices for market segmentation, in addition to rating-based regulation.
    Keywords: Corporate bond market; Index addition; Industry practices; Institutional investors; Liquidity; Market segmentation; Rating agencies; Rating-based regulation
    JEL: G12 G14
    Date: 2012–08
  4. By: Carlos León; Karen Leiton; Alejandro Reveiz
    Abstract: Financial basics and intuition stresses the importance of investment horizon for risk management and asset allocation. However, the beta parameter of the Capital Asset Pricing Model (CAPM) is invariant to the holding period. Such contradiction is due to the assumption of long-term independence of financial returns; an assumption that has been proven erroneous. Following concerns regarding the impact of the long-term dependence assumption on risk (Holton, 1992), this paper quantifies and fixes the CAPM’s bias resulting from this abiding –but flawed- assumption. The proposed procedure is based on Greene and Fielitz (1980) seminal work on the application of fractional Brownian motion to CAPM, and on a revised technique for estimating time-series’ fractal dimension with the Hurst exponent (León and Vivas, 2010; León and Reveiz, 2011a). Using a set of 85 stocks from the S&P100, this paper finds that relaxing the long-term independence assumption results in significantly different estimations of beta. According to three tests herein implemented with a 99% confidence level, more than 60% of the stocks exhibit significantly different beta parameters. Hence, expected returns are biased; on average, the bias is about ±60bps for a contemporary one-year investment horizon. Thus, as emphasized by Holton (1992), risk is a two-dimensional quantity, with holding period almost as important as asset class. The procedure herein proposed is valuable since it parsimoniously achieves an investment
    Keywords: CAPM, Hurst exponent, long-term dependence, fractional Brownian motion, asset allocation, investment horizon. Classification JEL: G12, G14, G32, G20, C14
    Date: 2012–08
  5. By: Dirk G Baur (Finance Discipline Group, UTS Business School, University of Technology, Sydney)
    Abstract: This paper studies the exposure of Australian gold-mining firms to changes in the gold price, the stock market and the Australian dollar - US dollar exchange rate. The empirical analysis uses daily, weekly and monthly data of all gold-mining firms in the S&P/ASX All Ordinaries Gold Index for the period from January 1980 to December 2010 and finds that the average gold beta is 0.67 for gold denominated in US dollar and 0.38 for gold denominated in Australian dollars. The study also finds substantial variation of gold betas through time which indicates managerial flexibility and real optionality. Interestingly, the average exposure of the firms decreased in the recent gold bull market reducing the attractiveness of gold-mining firms relative to investments in bullion.
    Keywords: gold; gold-mining stocks; asymmetric payoff; real options; exchange-traded funds
    Date: 2012–08–01
  6. By: Blommestein, Hans J.; Eijffinger, Sylvester C W; Qian, Zongxin
    Abstract: We study the determinants for the sovereign credit default swap (CDS) spreads of five Euro-area countries (Greece, Ireland, Italy, Portugal, Spain) in the post-Lehman-Brothers period. We find that there are regime switches in the process of sovereign CDS spread changes. We consider three alternative empirical hypotheses associated with regime switches. Under the first hypothesis, there are rational sunspot equilibria. Under the second hypothesis, there is a unique fundamental equilibrium and the regime switching is caused by changes in policy makers' preferences. The third hypothesis relaxes the rational expectations assumption. Under this hypothesis, indicators of the market fundamentals are not always precise. They are better indicators if cognitive biases are small and the rational expectations economy is a good approximation for reality. However, if market uncertainties enlarge the cognitive biases, the market-based indicators of fundamentals are no longer precise. In this case, they are not useful for CDS pricing. We find that the first two hypotheses are difficult to fit the data and the third hypothesis provides a good explanation for the sovereign CDS spread dynamics in our sample.
    Keywords: Animal spirit; Euro; sovereign CDS
    JEL: F34 G15 P34
    Date: 2012–08

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