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on Financial Markets |
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Issue of 2013‒03‒02
twelve papers chosen by |
| By: | Sabrina Camargo; Silvio M. Duarte Queiros; Celia Anteneodo |
| Abstract: | Employing a recent technique which allows the representation of nonstationary data by means of a juxtaposition of locally stationary paths of different length, we introduce a comprehensive analysis of the key observables in a financial market: the trading volume and the price fluctuations. From the segmentation procedure we are able to introduce a quantitative description of statistical features of these two quantities, which are often named stylized facts, namely the tails of the distribution of trading volume and price fluctuations and a dynamics compatible with the U-shaped profile of the volume in a trading section and the slow decay of the autocorrelation function. The segmentation of the trading volume series provides evidence of slow evolution of the fluctuating parameters of each patch, pointing to the mixing scenario. By assuming that long-term features are the outcome of a statistical mixture of simple local forms, we test and compare different probability density functions to provide the long-term distribution of the trading volume, concluding that the log-normal gives the best agreement with the empirical distribution. Moreover, the segmentation of the magnitude price fluctuations are quite different from the results for the trading volume, indicating that changes in the statistics of price fluctuations occur at a faster scale than in the case of trading volume. |
| Date: | 2013–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1302.3197&r=fmk |
| By: | Robert Fernholz; Tomoyuki Ichiba; Ioannis Karatzas |
| Abstract: | A first-order model for a stock market assigns to each stock a return parameter and a variance parameter that depend only on the rank of the stock. A second-order model assigns these parameters based on both the rank and the name of the stock. First- and second-order models exhibit stability properties that make them appropriate as a backdrop for the analysis of the idiosyncratic behavior of individual stocks. Methods for the estimation of the parameters of second-order models are developed in this paper. |
| Date: | 2013–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1302.3870&r=fmk |
| By: | Adri\'an Carro; Ra\'ul Toral; Maxi San Miguel |
| Abstract: | A growing part of the behavioral finance literature has addressed some of the stylized facts of financial time series as macroscopic patterns emerging from herding interactions among groups of agents with heterogeneous trading strategies and a limited rationality. We extend a stochastic herding formalism introduced for the modeling of decision making among financial agents, in order to take also into account an external influence. In particular, we study the amplification of an external signal imposed upon the agents by a mechanism of resonance. This signal can be interpreted as an advertising or a public perception in favor or against one of the two possible trading behaviors, thus periodically breaking the symmetry of the system and acting as a continuously varying exogenous shock. The conditions for the ensemble of agents to more accurately follow the periodicity of the signal are studied, finding a maximum in the response of the system for a given range of values of both the noise and the frequency of the input signal. |
| Date: | 2013–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1302.6477&r=fmk |
| By: | Jozef Barun\'ik; Ji\v{r}\'i Kuka\v{c}ka |
| Abstract: | The cusp catastrophe theory has been primarily developed as a deterministic theory for systems that may respond to continuous changes in a control variables by a discontinuous change. While most of the systems in behavioral sciences are subject to noise, and in behavioral finance moreover to time-varying volatility, it may be difficult to apply the theory in these fields. This paper addresses the issue and proposes a two-step estimation methodology, which will allow us to apply the catastrophe theory to model stock market crashes. Utilizing high frequency data, we estimate the daily realized volatility from the returns in the first step and use the stochastic cusp catastrophe on the data normalized by the estimated volatility in the second step to study possible discontinuities in markets. We support our methodology by simulations where we also discuss the importance of stochastic noise and volatility in the deterministic cusp model. The methodology is empirically tested on almost 27 years of U.S. stock market evolution covering several important recessions and crisis periods. Results suggest that the proposed methodology provides an important shift in application of catastrophe theory to stock markets. We show that stock markets subject to noise and time-varying volatility shows strong bifurcation marks. Due to the very long sample period we also develop a rolling estimation approach, where we study the dynamics of the parameters and we find that while in the first half of the period stock markets showed strong marks of bifurcations, in the second half catastrophe theory was not able to confirm this behavior. Results may have an important implications for understanding the recent deep financial crisis of 2008. |
| Date: | 2013–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1302.7036&r=fmk |
| By: | Claudio Fontana |
| Abstract: | We propose a unified analysis of a whole spectrum of no-arbitrage conditions for financial market models based on continuous semimartingales. In particular, we focus on no-arbitrage conditions weaker than the classical notions of No Arbitrage and No Free Lunch with Vanishing Risk. We provide a complete characterisation of all no-arbitrage conditions, linking their validity to the existence and to the properties of (weak) martingale deflators and to the characteristics of the discounted asset price process. |
| Date: | 2013–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1302.7192&r=fmk |
| By: | Turan G. Bali (McDonough School of Business, Georgetown University); Lin Peng (Zicklin School of Business, Baruch College); Yannan Shen (Zicklin School of Business, Baruch College); Yi Tang (Schools of Business, Fordham University) |
| Abstract: | This paper investigates how the stock market reacts to firm level liquidity shocks. We find that negative and persistent liquidity shocks not only lead to lower contemporaneous returns, but also predict negative returns for up to six months in the future. Long-short portfolios sorted on past liquidity shocks generate a raw and risk-adjusted return of more than 1% per month. This economically and statistically significant relation is robust across alternative measures of liquidity shocks, different sample periods, and after controlling for various risk factors and firm characteristics. Furthermore, the documented effect is stronger for small stocks, stocks with low analyst coverage and institutional holdings, and for less liquid stocks. Our evidence suggests that the stock market underreacts to firm level liquidity shocks, and that this underreaction can be driven by investor inattention as well as illiquidity. |
| Keywords: | Stock returns, liquidity shocks, stock market reactions, underreaction, investor attention. |
| JEL: | G10 G11 G12 G14 C13 |
| Date: | 2013–02 |
| URL: | http://d.repec.org/n?u=RePEc:koc:wpaper:1304&r=fmk |
| By: | Turan G. Bali (McDonough School of Business, Georgetown University); Robert F. Engle (New York University Stern School of Business); Yi Tang (Schools of Business, Fordham University) |
| Abstract: | This paper investigates the significance of dynamic conditional beta in predicting the cross-sectional variation in expected stock returns. The results indicate that the time-varying conditional beta is alive and well in the cross-section of daily stock returns. Portfolio-level analyses and firm-level cross-sectional regressions indicate a positive and significant relation between dynamic conditional beta and future returns on individual stocks. An investment strategy that goes long stocks in the highest conditional beta decile and shorts stocks in the lowest conditional beta decile produces average returns and alphas of 8% per annum. These results are robust to controls for size, book-tomarket, momentum, short-term reversal, liquidity, co-skewness, idiosyncratic volatility, and preference for lottery-like assets. |
| Keywords: | Dynamic conditional beta, conditional CAPM, ICAPM, and expected stock returns. |
| JEL: | G10 G11 C13 |
| Date: | 2013–02 |
| URL: | http://d.repec.org/n?u=RePEc:koc:wpaper:1305&r=fmk |
| By: | Turan G. Bali (McDonough School of Business, Georgetown University); Hao Zhou (Division of Research and Statistics, Federal Reserve Board) |
| Abstract: | A conditional asset pricing model with risk and uncertainty implies that the time-varying exposures of equity portfolios to the market and uncertainty factors carry positive risk premiums. The empirical results from the size, book-to-market, and industry portfolios as well as individual stocks indicate that the conditional covariances of equity portfolios (individual stocks) with market and uncertainty predict the time-series and cross-sectional variation in stock returns. We find that equity portfolios that are highly correlated with economic uncertainty proxied by the variance risk premium (VRP) carry a significant, annualized 6 to 8 percent premium relative to portfolios that are minimally correlated with VRP. |
| Keywords: | Risk, Uncertainty, Expected Returns, ICAPM, Time-Series and Cross-Sectional Stock Returns, Variance Risk Premium, Conditional Asset Pricing Model. |
| JEL: | G10 G11 C13 |
| Date: | 2013–02 |
| URL: | http://d.repec.org/n?u=RePEc:koc:wpaper:1306&r=fmk |
| By: | Luca Papi (Universit… Politecnica delle Marche, MoFiR); Andrea Filippo Presbitero (Universit… Politecnica delle Marche, MoFiR); Alberto Zazzaro (Universit… Politecnica delle Marche, MoFiR) |
| Abstract: | In this paper we look at the effect of International Monetary Fund (IMF) lending programs on banking crises in a large sample of developing countries, over the period 1965-2010. The endogeneity of the Fund intervention is addressed by adopting an instrumental variable (IV) strategy, in which the degree of political similarity between IMF borrowers and the G-7 is taken as an instrument for the likelihood of a country signing an IMF lending arrangement. Controlling for the standard determinants of banking crises, the IV estimates suggest that previous IMF borrowers are significantly less likely to experience a banking crisis. We also provide evidence suggesting that compliance with conditionality matters, consistent with the importance of IMF-supported financial reform, and that the positive effect of the Fund intervention on banking sector stability works through a direct liquidity provision effect. |
| Keywords: | Banking crises, IMF programs, Political economy |
| JEL: | F33 F34 F35 O11 |
| Date: | 2013–02 |
| URL: | http://d.repec.org/n?u=RePEc:anc:wmofir:80&r=fmk |
| By: | Hyong-Chol O; Jong-Zun Jo |
| Abstract: | We study the pricing problem for corporate defaultable bond from the viewpoint of the investors outside the firm that could not exactly know about the information of firm. We consider the problem for pricing of corporate defaultable bond in the case that the firm value is only declared in some fixed discrete time and unexpected default intensity is determined by the declared firm value. Here we provide a partial differential equation model for such a defaultable bond and give its pricing formula. Our pricing model is derived to a solving problem of a partial differential equation with random constant default intensity and a terminal value of the binary type. Our main method is to use the solving method of a partial differential equation for bond pricing with constant default intensity in every subinterval and to take expectation to remove the random constants. |
| Date: | 2013–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1302.3654&r=fmk |
| By: | Giuseppe Campolieti; Roman N. Makarov; Karl Wouterloot |
| Abstract: | We consider a special family of occupation-time derivatives, namely proportional step options introduced by Linetsky in [Math. Finance, 9, 55--96 (1999)]. We develop new closed-form spectral expansions for pricing such options under a class of nonlinear volatility diffusion processes which includes the constant-elasticity-of-variance (CEV) model as an example. In particular, we derive a general analytically exact expression for the resolvent kernel (i.e. Green's function) of such processes with killing at an exponential stopping time (independent of the process) of occupation above or below a fixed level. Moreover, we succeed in Laplace inverting the resolvent kernel and thereby derive newly closed-form spectral expansion formulae for the transition probability density of such processes with killing. The spectral expansion formulae are rapidly convergent and easy-to-implement as they are based simply on knowledge of a pair of fundamental solutions for an underlying solvable diffusion process. We apply the spectral expansion formulae to the pricing of proportional step options for four specific families of solvable nonlinear diffusion asset price models that include the CEV diffusion model and three other multi-parameter state-dependent local volatility confluent hypergeometric diffusion processes. |
| Date: | 2013–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1302.3771&r=fmk |
| By: | Damiano Brigo; Jo\~ao Garcia; Nicola Pede |
| Abstract: | After the beginning of the credit and liquidity crisis, financial institutions have been considering creating a convertible-bond type contract focusing on Capital. Under the terms of this contract, a bond is converted into equity if the authorities deem the institution to be under-capitalized. This paper discusses this Contingent Capital (or Coco) bond instrument and presents a pricing methodology based on firm value models. The model is calibrated to readily available market data. A stress test of model parameters is illustrated to account for potential model risk. Finally, a brief overview of how the instrument performs is presented. |
| Date: | 2013–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1302.6629&r=fmk |