nep-fmk New Economics Papers
on Financial Markets
Issue of 2014‒04‒05
ten papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Microscopic determinants of the weak-form efficiency of an artificial order-driven stock market By Jian Zhou; Gao-Feng Gu; Zhi-Qiang Jiang; Xiong Xiong; Wei Zhang; Wei-Xing Zhou
  2. Stock Price Booms and Expected Capital Gains By Klaus Adam; Johannes Beutel; Albert Marcet
  3. Market pricing of credit rating signals By Grothe, Magdalena
  4. Commonality in hedge fund returns: driving factors and implications By Bussière, Matthieu; Hoerova, Marie; Klaus, Benjamin
  5. Sovereign credit ratings, market volatility, and financial gains By Afonso, António; Gomes, Pedro; Taamouti, Abderrahim
  6. An Empirical Study of Trade Dynamics in the Fed Funds Market By Afonso, Gara M.; Lagos, Ricardo
  7. The pricing of sovereign risk and contagion during the European sovereign debt crisis By Beirne, John; Fratzscher, Marcel
  8. The Distribution of wealth and the MPC: implications of new European data By Carroll, Christopher D.; Slacalek, Jiri; Tokuoka, Kiichi
  9. Asian Fragmentation in the Global Financial Crisis By Toshihiro Okubo; Fukunari Kimura; Nozomu Teshima
  10. An agent-based computational model for China's stock market and stock index futures market By Hai-Chuan Xu; Wei Zhang; Xiong Xiong; Wei-Xing Zhou

  1. By: Jian Zhou (ECUST); Gao-Feng Gu (ECUST); Zhi-Qiang Jiang (ECUST); Xiong Xiong (TJU); Wei Zhang (TJU); Wei-Xing Zhou (ECUST)
    Abstract: Stock markets are efficient in the weak form in the sense that no significant autocorrelations can be identified in the returns. However, the microscopic mechanisms are unclear. We aim at understanding the impacts of order flows on the weak-form efficiency through computational experiments based on an empirical order-driven model. Three possible determinants embedded in the model are investigated, including the tail heaviness of relative prices of the placed orders characterized by the tail index $\alpha_x$, the degree of long memory in relative prices quantified by its Hurst index $H_x$, and the strength of long memory in order direction depicted by $H_x$. It is found that the degree of autocorrelations in returns (quantified by its Hurst index $H_r$) is negatively correlated with $\alpha_x$ and $H_x$ and positively correlated with $H_s$. In addition, the values of $\alpha_x$ and $H_x$ have negligible impacts on $H_r$, whereas $H_s$ exhibits a dominating impact on $H_r$. Our results suggest that stock markets are complex adaptive systems and self-organize to a critical state in which the returns are not correlated.
    Date: 2014–03
  2. By: Klaus Adam; Johannes Beutel; Albert Marcet
    Abstract: The booms and busts in U.S. stock prices over the post-war period can to a large extent be explained by fluctuations in investors' subjective capital gains expectations. Survey measures of these expectations display excessive optimism at market peaks and excessive pessimism at market throughs. Formally incorporating subjective price beliefs into an otherwise standard asset pricing model with utility maximizing investors, we show how subjective belief dynamics can temporarily delink stock prices from their fundamental value and give rise to asset price booms that ultimately result in a price bust. The model successfully replicates (1) the volatility of stock prices and (2) the positive correlation between the price dividend ratio and expected returns observed in survey data. We show that models imposing objective or 'rational' price expectations cannot simultaneously account for both facts. Our findings imply that large part of U.S. stock price fluctuations are not due to standard fundamental forces, instead result from self-reinforcing belief dynamics triggered by these fundamentals.
    JEL: G12 D84
    Date: 2014–03–24
  3. By: Grothe, Magdalena
    Abstract: This paper contributes new evidence on market pricing of rating changes. We examine the relation between spreads and ratings for a very large and comprehensive sample of corporate bonds, which allows us to test for country- and industry-specific effects, as well as to explore the differences between the calm and distressed market conditions. The results show that the effects of rating actions on market prices are significant and depend on the current state of the market. While during favourable market conditions rating actions are not crucial for market pricing, they become very significant in the periods of crisis. JEL Classification: G12, G14, G01, G21
    Keywords: corporate bond spreads, credit ratings, pricing of risk
    Date: 2013–12
  4. By: Bussière, Matthieu; Hoerova, Marie; Klaus, Benjamin
    Abstract: We measure the commonality in hedge fund returns, identify its main driving factor and analyse its implications for financial stability. We find that hedge funds’ commonality increased significantly from 2003 until 2006. We attribute this rise mainly to the increase in hedge funds’ exposure to emerging market equities, which we identify as a common factor in hedge fund returns over this period. Our results show that funds with a high commonality were affected disproportionately by illiquidity and exhibited negative returns during the subsequent financial crisis, thereby providing little diversification benefits to the financial system and to investors. JEL Classification: G01, G10, G11, G23
    Keywords: commonality, financial crisis, hedge funds, liquidity, risk factors
    Date: 2014–03
  5. By: Afonso, António; Gomes, Pedro; Taamouti, Abderrahim
    Abstract: The reaction of EU bond and equity market volatilities to sovereign rating announcements (Standard & Poor’s, Moody’s, and Fitch) is investigated using a panel of daily stock market and sovereign bond returns. The parametric volatilities are filtered using EGARCH specifications. The estimation results show that upgrades do not have significant effects on volatility, but downgrades increase stock and bond market volatility. Contagion is present, with sovereign rating announcements creating interdependence among European financial markets with upgrades (downgrades) in one country leading to a decrease (increase) in volatility in other countries. The empirical results show also a financial gain and risk (value-at-risk) reduction for portfolio returns when taking into account sovereign credit ratings’ information for volatility modelling, with financial gains decreasing with higher risk aversion. JEL Classification: C22, C23, E44, G11, G15, H30
    Keywords: EGARCH, financial gain, optimal portfolio, risk management, sovereign ratings, stock market returns, value-at-risk, volatility, yields
    Date: 2014–03
  6. By: Afonso, Gara M. (Federal Reserve Bank of New York); Lagos, Ricardo (Federal Reserve Bank of Minneapolis)
    Abstract: We use minute-by-minute daily transaction-level payments data to document the cross-sectional and time-series behavior of the estimated prices and quantities negotiated by commercial banks in the fed funds market. We study the frequency and volume of trade, the size distribution of loans, the distribution of bilateral fed funds rates, and the intraday dynamics of the reserve balances held by commercial banks. We find evidence of the importance of the liquidity provision achieved by commercial banks that act as de facto intermediaries of fed funds.
    Keywords: Monetary policy; Federal funds market; Federal funds rates
    JEL: E42 E44 G21
    Date: 2014–03–17
  7. By: Beirne, John; Fratzscher, Marcel
    Abstract: The paper analyses the drivers of sovereign risk for 31 advanced and emerging economies during the European sovereign debt crisis. It shows that a deterioration in countries’ fundamentals and fundamentals contagion – a sharp rise in the sensitivity of financial markets to fundamentals – are the main explanations for the rise in sovereign yield spreads and CDS spreads during the crisis, not only for euro area countries but globally. By contrast, regional spill overs and contagion have been less important, including for euro area countries. The paper also finds evidence for herding contagion – sharp, simultaneous increases in sovereign yields across countries – but this contagion has been concentrated in time and among a few markets. Finally, empirical models with economic fundamentals generally do a poor job in explaining sovereign risk in the pre-crisis period for European economies, suggesting that the market pricing of sovereign risk may not have been fully reflecting fundamentals prior to the crisis. JEL Classification: E44, F30, G15, C23, H63
    Keywords: bond spreads, CDS spreads, contagion, ratings, sovereign debt crisis, sovereign risk
    Date: 2013–12
  8. By: Carroll, Christopher D.; Slacalek, Jiri; Tokuoka, Kiichi
    Abstract: Using new micro data on household wealth from fifteen European countries, the Household Finance and Consumption Survey, we first document the substantial cross-country variation in how various measures of wealth are distributed across individual households. Through the lens of a standard, realistically calibrated model of buffer-stock saving with transitory and permanent income shocks we then study how cross-country differences in the wealth distribution and household income dynamics affect the marginal propensity to consume out of transitory shocks (MPC). We find that the aggregate consumption response ranges between 0.1 and 0.4 and is stronger (i) in economies with large wealth inequality, where a larger proportion of households has little wealth, (ii) under larger transitory income shocks and (iii) when we consider households only using liquid assets (rather than net wealth) to smooth consumption. JEL Classification: D12, D31, D91, E21
    Keywords: consumption dynamics, cross-country comparisons, liquid assets, MPC, wealth inequality
    Date: 2014–03
  9. By: Toshihiro Okubo; Fukunari Kimura; Nozomu Teshima
    Abstract: This paper studies the impact of the Global Financial Crisis of 2008 on Japanese exports, focusing on international production networks in machinery sectors. For our survival analysis, we estimate a Cox proportional hazards model. Consequently, we find that Japanese exports to Asian countries, parts and components trade in particular, were less likely to stop during the crisis. Even if they stopped, such trade is more likely to be revived. Therefore, regardless of the worldwide economic crisis, Japan maintained trade relationships in parts and components in the machinery sectors.
    Keywords: Financial crisis, Asian trade, parts and components, exit-entry diagram, survival analysis
    JEL: F14
    Date: 2014–03
  10. By: Hai-Chuan Xu (TJU); Wei Zhang (TJU); Xiong Xiong (TJU); Wei-Xing Zhou (ECUST)
    Abstract: This study presents an agent-based computational cross-market model for Chinese equity market structure, which includes both stocks and CSI 300 index futures. In this model, we design several stocks and one index futures to simulate this structure. This model allows heterogeneous investors to make investment decisions with restrictions including wealth, market trading mechanism, and risk management. Investors' demands and order submissions are endogenously determined. Our model successfully reproduces several key features of the Chinese financial markets including spot-futures basis distribution, bid-ask spread distribution, volatility clustering and long memory in absolute returns. Our model can be applied in cross-market risk control, market mechanism design and arbitrage strategies analysis.
    Date: 2014–03

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