nep-fmk New Economics Papers
on Financial Markets
Issue of 2013‒08‒31
three papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Forecasting Stock Returns under Economic Constraints By Davide Pettenuzzo; Allan Timmermann; Rossen Valkanov
  2. Stock index hedge using trend and volatility regime switch model considering hedging cost By Su, EnDer
  3. An Asian Perspective on Global Financial Reforms By Morgan, Peter J.; Pontines, Victor

  1. By: Davide Pettenuzzo (Economics Department, Brandeis University); Allan Timmermann (University of California, San Diego); Rossen Valkanov (University of California, San Diego)
    Abstract: We propose a new approach to imposing economic constraints on time-series forecasts of the equity premium. Economic constraints are used to modify the posterior distribution of the parameters of the predictive return regression in a way that better allows the model to learn from the data. We consider two types of constraints: Non-negative equity premia and bounds on the conditional Sharpe ratio, the latter of which incorporates timevarying volatility in the predictive regression framework. Empirically, we Önd that economic constraints systematically reduce uncertainty about model parameters, reduce the risk of selecting a poor forecasting model, and improve both statistical and economic measures of out-of-sample forecast performance. The Sharpe ratio constraint, in particular, results in considerable economic gains.
    Keywords: Economic constraints; Sharpe ratio, Equity premium predictions; Bayesian analysis
    JEL: C11 C22 G11 G12
    Date: 2013–05
  2. By: Su, EnDer
    Abstract: This paper studies the risk hedging between stock index and underlying futures. The hedging ratios are optimized using the mean-variance utility function as considering the hedging cost. The trend of returns and variance are estimated by the model of regime switch on both vector autoregression (VAR) and GARCH(1,1) compared to three restricted models: VAR switch only, GARCH(1,1) switch only, and no switch. The hedge portfolio is constructed by Morgan Stanley Taiwan Index (MSTI) and Singapore Traded MSTI futures. The hedge horizon is set as a week to reduce the hedging cost and the weekly in-sample data cover from 08/09/2001 to 05/31/2007. The rolling window technique is used to evaluate the hedge performances of out-of-sample period spanning subprime, Greek debt, and post-risk durations. The subprime period indeed is evidenced very vital to achieve the hedge performance. All models perform surprisingly far above average during subprime period. The hedge ratios indeed are the tradeoff between maximum expected return and minimum variance. It is demonstrated challenging for all models to increase returns and reduce risk together. The hedge context is further classified into four hedge states: uu, ud, du, and dd (u and d denote respectively usual and down) using the state probabilities of series. The regime switch models are found to have much greater wealth increase when in dd state. It is decisive to hedge risk in dd state when volatility is extensively higher as observed recurrently in subprime period. Remarkably, the trend switch is found having larger wealth increase while the volatility switch is not found prominent between models. While the no switch model has larger utility increase in uu state as most observed in Greek debt or post risk period, its performance is far below average like other models.
    Keywords: stock index, regime switch, hedging cost, hedging ratio
    JEL: C13 C51
    Date: 2013–01–09
  3. By: Morgan, Peter J. (Asian Development Bank Institute); Pontines, Victor (Asian Development Bank Institute)
    Abstract: The purpose of this study is to better understand the likely impact on Asian economies and financial institutions of various recent global financial reforms, including Basel III capital adequacy and liquidity rules. Overall, the authors find that the Basel III capital adequacy rules are likely to have limited impacts on economic growth in Asia, but other financial regulations, including liquidity standards and rules for over-the-counter (OTC) derivatives, could have stunting effects on financial development in the region.
    Keywords: asian economies; financial institutions; global financial reforms; basel iii; capital adequacy rules; liquidity rules; otc derivatives
    JEL: E17 G01 G18 G21
    Date: 2013–08–22

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