New Economics Papers
on Financial Markets
Issue of 2013‒06‒16
three papers chosen by

  1. On the Risk Return Relationship. By Jianxin Wang; Minxian Yang
  2. Phase Transition in the S&P Stock Market By Matthias Raddant; Friedrich Wagner
  3. Why Did Financial Institutions Sell RMBS at Fire Sale Prices during the Financial Crisis? By Merrill, Craig B.; Nadauld, Taylor; Sherlund, Shane M.

  1. By: Jianxin Wang (UTS Business School, the University of Technology Sydney); Minxian Yang (School of Economics, the University of New South Wales)
    Abstract: While the risk return trade-off theory suggests a positive relationship between the expected return and the conditional volatility, the volatility feedback theory implies a channel that allows the conditional volatility to negatively affect the expected return. We examine the effects of the risk return trade-off and the volatility feedback in a model where both the return and its volatility are influenced by news arrivals. Our empirical analysis shows that the two effects have approximately the same size with opposite signs for the daily excess returns of seven major developed markets. For the same data set, we also find that a linear relationship between the expected return and the conditional standard deviation is preferable to polynomial-type nonlinear specifications.
    Keywords: Risk premium, volatility feedback, GARCH-in-mean, Maximum likelihood, Mixture distributions, Time series.
    Date: 2012–05
  2. By: Matthias Raddant; Friedrich Wagner
    Abstract: We analyze the stock prices of the S&P market from 1987 until 2012 with the covariance matrix of the firm returns determined in time windows of several years. The eigenvector belonging to the leading eigenvalue (market) exhibits in its long term time dependence a phase transition with an order parameter which can be interpreted within an agent-based model. From 1995 to 2005 the market is in an ordered state and after 2005 in a disordered state.
    Date: 2013–06
  3. By: Merrill, Craig B. (Brigham Young University); Nadauld, Taylor (Brigham Young University); Sherlund, Shane M. (OH State University)
    Abstract: Much attention has been paid to the large decreases in value of non-agency residential mortgage-backed securities (RMBS) during the financial crisis. Many observers have argued that the fall in prices was partly caused by fire sales. We use capital requirements and accounting rules to identify circumstances where financial institutions had incentives to engage in fire sales and then examine whether such sales occurred. For financial institutions subject to credit-sensitive capital requirements, capital requirements increase as an asset's credit becomes impaired. When accounting rules require such an asset's value to be marked-to-market and the fair value loss to be recognized in earnings, a capital-constrained firm can improve its capital position by selling the credit-impaired asset even if it has to accept a liquidity discount to do so. In contrast, a financial firm whose fair value losses are not recognized in earnings for the purpose of calculating capital requirements is more likely to satisfy capital requirements by selling liquid assets whose value has not fallen and hence would be unlikely to engage in fire sales. Using a sample of 5,000 repeat transactions of non-agency RMBS by insurance companies from 2006 to 2009, we show that insurance companies that became more capital-constrained because of operating losses (uncorrelated with RMBS credit quality) and also recognized fair value losses sold comparable RMBS at much lower prices than other insurance companies during the crisis.
    JEL: G01 G21 G22 G23 M41
    Date: 2013–02

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.