New Economics Papers
on Financial Markets
Issue of 2013‒08‒16
five papers chosen by

  1. Herding in financial markets: Bridging the gap between theory and evidence By Christopher Boortz; Simon Jurkatis; Stephanie Kremer; Dieter Nautz
  2. The systemic risk of European banks during the financial and sovereign debt crises By Lamont Black; Ricardo Correa; Xin Huang; Hao Zhou
  3. Mortgage Hedging in Fixed Income Markets By Aytek Malkhozov; Philippe Mueller; Andrea Vedolin; Gyuri Venter
  4. Local Variance Gamma and Explicit Calibration to Option Prices By Peter Carr; Sergey Nadtochiy
  5. Insolvency and Contagion in the Brazilian Interbank Market By Sergio R. S. Souza; Benjamin M. Tabak; Solange M. Guerra

  1. By: Christopher Boortz; Simon Jurkatis; Stephanie Kremer; Dieter Nautz
    Abstract: Due to data limitations and the absence of testable, model-based predictions, theory and evidence on herd behavior are only loosely connected. This paper attempts to close this gap in the herding literature. From a theoretical perspective, we use numerical simulations of a herd model to derive new, theory-based predictions for aggregate herding intensity. From an empirical perspective, we employ high-frequency, investor-specic trading data to test the theory-implied impact of information risk and market stress on herding. Conrming model predictions, our results show that herding intensity increases with information risk. In contrast, herding measures estimated for the nancial crisis period cannot be explained by the herd model. This suggests that the correlation of trades observed during the crisis is mainly due to the common reaction of investors to new public information and should not be misinterpreted as herd behavior.
    Keywords: Herd Behavior, Institutional Trading, Model Simulation
    JEL: G11 G24
    Date: 2013–07
  2. By: Lamont Black; Ricardo Correa; Xin Huang; Hao Zhou
    Abstract: We propose a hypothetical distress insurance premium (DIP) as a measure of the European banking systemic risk, which integrates the characteristics of bank size, default probability, and interconnectedness. Based on this measure, the systemic risk of European banks reached its height in late 2011 around € 500 billion. We find that the sovereign default spread is the factor driving this heightened risk in the banking sector during the European debt crisis. The methodology can also be used to identify the individual contributions of over 50 major European banks to the systemic risk measure. This approach captures the large contribution of a number of systemically important European banks, but Italian and Spanish banks as a group have notably increased their systemic importance. We also find that bank-specific fundamentals predict the one-year-ahead systemic risk contribution of our sample of banks in an economically meaningful way.
    Date: 2013
  3. By: Aytek Malkhozov; Philippe Mueller; Andrea Vedolin; Gyuri Venter
    Abstract: We study the feedback from hedging mortgage portfolios on the level and volatility of interest rates. We incorporate the supply shocks resulting from hedging into an otherwise standard dynamic term structure model, and derive two sets of predictions which are strongly supported by the data: First, the duration of mortgage-backed securities (MBS) positively predicts excess bond returns, especially for longer maturities. Second, MBS convexity increases yield and swaption implied volatilities, and this effect has a hump-shaped term structure. Empirically, neither duration, nor convexity are spanned by yield factors. A calibrated version of our model replicates salient features of first and second moments of bond yields
    Date: 2013
  4. By: Peter Carr; Sergey Nadtochiy
    Abstract: In some options markets (e.g. commodities), options are listed with only a single maturity for each underlying. In others, (e.g. equities, currencies), options are listed with multiple maturities. In this paper, we provide an algorithm for calibrating a pure jump Markov martingale model to match the market prices of European options of multiple strikes and maturities. This algorithm only requires solutions of several one-dimensional root-search problems, as well as application of elementary functions. We show how to construct a time-homogeneous process which meets a single smile, and a piecewise time-homogeneous process which can meet multiple smiles.
    Date: 2013–08
  5. By: Sergio R. S. Souza; Benjamin M. Tabak; Solange M. Guerra
    Abstract: This paper analyzes the financial institutions (FIs) that operate in the Brazilian Interbank Market, investigating, through simulations, the potential contagion that they present, the contagion losses' and the contagion route associated to FIs' bankruptcies, and the value of the 1-year expected loss of the financial system. The paper also computes the possibility of contagion of other markets triggered by FIs' defaults in the interbank market. Besides, it identifies contagion transmitter FIs and losses amplifier FIs in the market studied. The analyses performed found no particularly important source of stress in the Brazilian financial system, in the period.
    Date: 2013–08

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