New Economics Papers
on Financial Markets
Issue of 2014‒03‒15
nine papers chosen by

  1. The Basics of "Too Big to Fail" By Lawrence J. White
  2. An update on emu sovereign yield spread drivers in times of crisis: a panel data analysis By Marta Gómez-Puig; Simón Sosvilla-Rivero; María del Carmen Ramos-Herrera
  3. Do Google Trend data contain more predictability than price returns? By Damien Challet; Ahmed Bel Hadj Ayed
  5. Modelling Credit Default Swaps: Market-Standard Vs Incomplete-Market Models By Michael B. Walker
  6. The impact of liquidity on inflation-linked bonds: A hypothetical indexed bonds approach By Julia Auckenthaler; Alexander Kupfer; Rupert Sendlhofer
  7. Basel III, Clubs and Eurozone Asymmetries By Michele Fratianni; John Pattison
  8. The Conditional Pricing of Systematic and Idiosyncratic Risk in the UK Equity Market By John Cotter; Niall O'Sullivan; Francesco Rossi
  9. Price Limits and Stock Market Volatility in China By Wang, Dingyan; Chong, Terence Tai-Leung; Chan, Wing Hong

  1. By: Lawrence J. White
    Date: 2014
  2. By: Marta Gómez-Puig (Department of Economic Theory, Universitat de Barcelona); Simón Sosvilla-Rivero (Department of Quantitative Economics, Universidad Complutense de Madrid); María del Carmen Ramos-Herrera (Department of Quantitative Economics, Universidad Complutense de Madrid)
    Abstract: We empirically investigate the determinants of EMU sovereign bond yield spreads with respect to the German bund. Using panel data techniques, we examine the role of a wide set of potential drivers. To our knowledge, this paper presents one of the most exhaustive compilations of the variables used in the literature to study the behaviour of sovereign yield spreads and, in particular, to gauge the effect on these spreads of changes in market sentiment and risk aversion. We use a sample of both central and peripheral countries from January 1999 to December 2012 and assess whether there were significant changes after the outbreak of the euro area debt crisis. Our results suggest that the rise in sovereign risk in central countries can only be partially explained by the evolution of local macroeconomic variables in those countries. Besides, without exception, the marginal effects of sovereign spread drivers (specifically, the variables that measure global market sentiment) increased during the crisis compared to the pre-crisis period, especially in peripheral countries.
    Keywords: Sovereign bond spreads, Panel data, Eurozone
    JEL: C33 C52 E44 F36 G15
    Date: 2014–03
  3. By: Damien Challet; Ahmed Bel Hadj Ayed
    Abstract: Using non-linear machine learning methods and a proper backtest procedure, we critically examine the claim that Google Trends can predict future price returns. We first review the many potential biases that may influence backtests with this kind of data positively, the choice of keywords being by far the greatest culprit. We then argue that the real question is whether such data contain more predictability than price returns themselves: our backtest yields a performance of about 17bps per week which only weakly depends on the kind of data on which predictors are based, i.e. either past price returns or Google Trends data, or both.
    Date: 2014–03
    Date: 2014
  5. By: Michael B. Walker
    Abstract: Recently, incomplete-market techniques have been used to develop a model applicable to credit default swaps (CDSs) with results obtained that are quite different from those obtained using the market-standard model. This article makes use of the new incomplete-market model to further study CDS hedging and extends the model so that it is capable treating single-name CDS portfolios. Also, a hedge called the vanilla hedge is described, and with it, analytic results are obtained explaining the striking features of the plot of no-arbitrage bounds versus CDS maturity for illiquid CDSs. The valuation process that follows from the incomplete-market model is an integrated modelling and risk management procedure, that first uses the model to find the arbitrage-free range of fair prices, and then requires risk management professionals for both the buyer and the seller to find, as a basis for negotiation, prices that both respect the range of fair prices determined by the model, and also benefit their firms. Finally, in a section on numerical results, the striking behavior of the no-arbitrage bounds as a function of CDS maturity is illustrated, and several examples describe the reduction in risk by the hedging of single-name CDS portfolios.
    Date: 2014–03
  6. By: Julia Auckenthaler; Alexander Kupfer; Rupert Sendlhofer
    Abstract: The sovereign’s intention to issue inflation-linked bonds (ILB) is to save money. More than 15 years’ experience with this financial instrument in the United States and in several other countries has led to the conclusion that these bonds are costly and basically characterized by low liquidity issues. Recently, various papers have started to analyze the impact of liquidity on ILB yields. This paper summarizes studies concerning ILB liquidity at a glance and adds a new estimation strategy of the liquidity premium based on Campbell & Shiller’s (1996) hypothetical ILB yields. We calculate the difference between observed and hypothetical ILB yields, regress this time series on a set of ILB-specific liquidity as well as general market uncertainty measures and find statistically and economically significant effects of the liquidity measures for the United States, the United Kingdom and Canada.
    Keywords: Inflation-linked bonds, liquidity, hypothetical yields
    JEL: G12 G01 H63
    Date: 2014–03
  7. By: Michele Fratianni (Indiana University, Kelly School of Business, Bloomington US, Univ. Plitecnica Marche and MoFiR); John Pattison (retired banker)
    Abstract: Financial regulation has shifted from a system managed as an oligopoly dominated by the G2/G5 to expanded clubs like the Basel Committee for Banking Supervision. Expansive clubs have to agree to terms that are closer to the preferences of soft-regulation members. Yet, once a global agreement on minimum standards, such as Basel III, is reached, the transposition is left to national or regional regulators. Deviations from the Basel III standards are bound to occur; the complexity of the agreement will facilitate an asymmetric implementation of national regulation and supervision. On the high side, countries like the US, UK, Australia, some Scandinavian countries and Canada have chosen higher standards. On the low side, we should expect deviations to take place in those member countries of the Eurozone that are heterogeneous, have different preferences and tradeoffs between regulatory stringency and economic activity. The requirements of both global clubs and the EU regional club for transparency, monitoring and a level playing field will cause a collision between the interests of the clubs and their members.
    Keywords: Basel III clubs, Eurozone, asymmetries, financial regulation
    JEL: F33 F36 F42
    Date: 2014–03
  8. By: John Cotter (UCD School of Business, University College Dublin); Niall O'Sullivan (School of Economics and Centre for Investment Research, University College Cork); Francesco Rossi (UCD School of Business, University College Dublin)
    Abstract: We test whether firm idiosyncratic risk is priced in a large cross-section of U.K. stocks. A distinguishing feature of our paper is that our tests allow for a conditional relationship between systematic risk (beta) and returns in our tests, i.e., conditional on whether the excess market return is positive or negative. We find strong evidence in support of a conditional beta/return relationship which in turn reveals conditionality in the pricing of idiosyncratic risk. We find that idiosyncratic risk is significantly negatively priced in stock returns in down-markets. Although perhaps initially counter-intuitive, we describe the theoretical support for such a finding in the literature. Our results also reveal a strong role for liquidity, size and momentum factors in explaining the cross-section of U.K. stock returns.
    Keywords: asset pricing; idiosyncratic risk; turnover; conditional beta.
    JEL: G11 G12
    Date: 2014–02–19
  9. By: Wang, Dingyan; Chong, Terence Tai-Leung; Chan, Wing Hong
    Abstract: This paper explores the effects of price limits on the stock market of China during global market turmoils. The characteristics of stocks that hit the price limits more frequently under market turmoil are investigated. It is found that the price limit system increases volatility significantly during the downward price movement. Moreover, price limit delays the efficient price discovery for upward and downward price movements. Finally, actively-traded stocks with a higher positive correlation with the entire market in the property industry hit the price limits more frequently.
    Keywords: A-share market; Price limit; Financial crises.
    JEL: G1 G18
    Date: 2014–01–26

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