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on Financial Markets |
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Issue of 2014‒05‒04
seven papers chosen by |
| By: | Dongho Song (Department of Economics, University of Pennsylvania) |
| Abstract: | I provide empirical evidence of changes in the U.S. Treasury yield curve and related macroeconomic factors, and investigate whether the changes are brought about by external shocks, monetary policy, or by both. To explore this, I characterize bond market exposures to macroeconomic and monetary policy risks, using an equilibrium term structure model with recursive preferences in which inflation dynamics are endogenously determined. In my model, the key risks that affect bond market prices are changes in the correlation between growth and inflation and changes in the conduct of monetary policy. Using a novel estimation technique, I find that the changes in monetary policy affect the volatility of yield spreads, while the changes in the correlation between growth and inflation affect both the level as well as the volatility of yield spreads. Consequently, the changes in the correlation structure are the main contributor to bond risk premia and to bond market volatility. The time variations within a regime and risks associated with moving across regimes lead to the failure of the Expectations Hypothesis and to the excess bond return predictability regression of Cochrane and Piazzesi (2005), as in the data. |
| Keywords: | Monetary Policy Risks, Regime-Switching Macroeconomic Risks, Stochastic Volatility, Taylor-Rule, Term Structure |
| JEL: | E43 G12 |
| Date: | 2014–04–30 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:14-017&r=fmk |
| By: | Suleyman Hilmi Kal; Ferhat Arslaner; Nuran Arslaner |
| Abstract: | The paper is an investigation concerning whether the deviations of currencies from their fundamental values affects the relationship between economic fundamentals and exchange rates. To this end, a version of the sticky price monetary exchange rate model, which connects the exchange rates to economic fundamentals, is employed. And that model is extended by adding a two state time varying transition probability Markov regime switching process in which transition between regimes is linked to the rate of risk-adjusted excess returns in the currencies. This permits analysis of the transitional dynamics of exchange rates. Quarterly data of the most active four floating currencies are used in the model. These currencies are the Australian dollar, the Canadian dollar, the Japanese yen, and the British pound. The results provide evidence that the Sharpe ratios of debt and equity investments in the currencies influence the evolution of transitional dynamics of the exchange rates’ deviation from their fundamental values. As an extension of this result, it was found that the relationship between economic fundamentals and the nominal exchange rates are subject to change depending on the overvaluation or undervaluation of the currencies relative to their fundamental value. |
| Keywords: | Bond Price, Stock Price, Sharpe Ratio, Exchange Rates, Time Series Analysis, and Markov Switching Model |
| JEL: | C22 E44 G12 |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:bor:wpaper:1418&r=fmk |
| By: | Jørgen Vitting Andersen (Centre d'Economie de la Sorbonne); Ioannis Vrontos (Athens University of Economics and Business - Department of Statistics); Petros Dellaportas (Athens University of Economics and Business - Department of Statistics); Serge Galam (CEVIPOF - Center for Political Research) |
| Abstract: | Background: Since the attribution of the Nobel prize in 2002 to Kahneman for prospect theory, behavioral finance has become an increasingly important subfield of finance. However the main parts of behavioral finance, prospect theory included, understand financial markets through individual investment behavior. Behavioral finance thereby ignores any interaction between participants. Methodology: We introduce a socio-financial model that studies the impact of communication on the pricing in financial markets. Considering the simplest possible case where each market participant has either a positive (bullish) or negative (bearish) sentiment with respect to the market, we model the evolution of the sentiment in the population due to communication in subgroups of different sizes. Nonlinear feedback effects between the market performance and changes in sentiments are taking into account by assuming that the market performance is dependent on changes in sentiments (e.g. a large sudden positive change in bullishness would lead to more buying). The market performance in turn has an impact on the sentiment through the transition probabilities to change an opinion in a group of a given size. The idea is that if for example the market has observed a recent downturn, it will be easier for even a bearish minority to convince a bullish majority to change opinion compared to the case where the meeting takes place in a bullish upturn of the market. Conclusions: Within the framework of our proposed model financial markets stylized facts such as volatility clustering and extreme events may be perceived as arising due to abrupt sentiment changes via ongoing communication of the market participants. The model introduces a new volatility measure which is apt of capturing volatility clustering and from maximum likelihood analysis we are able to apply the model to real data and give additional long term insight into where a market is heading. |
| Keywords: | Communication, formation of prices, stylized facts. |
| JEL: | G02 G12 |
| Date: | 2014–04 |
| URL: | http://d.repec.org/n?u=RePEc:mse:cesdoc:14029&r=fmk |
| By: | Yi-Fang Liu (College of Management and Economics, China Center for Social Computing and Analytics and Centre d'Economie de la Sorbonne); Wei Zhang (College of Management and Economics, China Center for Social Computing and Analytics); Chao Xu (College of Management and Economics, China Center for Social Computing and Analytics); Jørgen Vitting Andersen (Centre d'Economie de la Sorbonne); Hai-Chuan Xu (College of Management and Economics, China Center for Social Computing and Analytics) |
| Abstract: | This paper studies the switching of trading strategies and its effect on the market volatility in a continuous double auction market. We describe the behavior when some uninformed agents, who we call switchers, decide whether or not to pay for information before they trade. By paying for the information they behave as informed traders. First, we verify that our model is able to reproduce some of the stylized facts in real financial markets. Next we consider the relationship between switching and the market volatility under different structures of investors. We find that there exists a positive relationship between the market volatility and the percentage of switchers. We therefore conclude that the switchers are a destabilizing factor in the market. However, for a given fixed percentage of switchers, the proportion of switchers that decide to buy information at a given moment of time is negatively related to the current market volatility. In other words, if more agents pay for information to know the fundamental value at some time, the market volatility will be lower. This is because the market price is closer to the fundamental value due to information diffusion between switchers. |
| Keywords: | Agent-based model, heterogeneity, switching behavior, market volatility. |
| JEL: | G11 G12 G14 |
| Date: | 2014–04 |
| URL: | http://d.repec.org/n?u=RePEc:mse:cesdoc:14031&r=fmk |
| By: | Evers, Corinna; Rohde, Johannes |
| Abstract: | Under the Basel II regulatory framework non-negligible statistical problems arise when backtesting risk measures. In this setting backtests often become infeasible due to a low number of violations leading to heavy size distortions. According to Escanciano and Olmo (2010, 2011) these problems persist when incorporating estimation and model risk by adjusting the asymptotic variance of the test statistics. In this paper, we analyze backtests based on hit and duration sequences in a univariate framework by running a simulation study in order to identify the problems of backtests that examine the adequacy of Value at Risk measures. One main finding indicates that backtests of all classes show heavy size distortions. These problems for the relevant Basel II set-up, however, cannot be alleviated by modifying backtests in a way that accounts for estimation risk or misspecification risk. |
| Keywords: | Model risk, backtesting, Value at risk |
| JEL: | C12 C52 G32 |
| Date: | 2014–04 |
| URL: | http://d.repec.org/n?u=RePEc:han:dpaper:dp-529&r=fmk |
| By: | Andrés Ramírez Hassan; Javier Pantoja Robayo |
| Abstract: | Currently, the world is facing a continuous process of integration in different aspects and financial markets are no exception to this development. Despite the fact that global integration is gradual, one can find some specific events that might help to accelerate this trend. This paper shows that after the financial crisis of 2008, which mainly occurred in the United States, the Latin American stock markets exhibit a higher level of convergence, measured by the correlation between the annual returns of their stock market indices. Additionally, we find convergence in the coefficient of sensitivity between Latin American and U.S. stock markets, using dynamic linear models at the regional level. In particular, we uncover consistent movements in the levels of sensitivity between the daily annual returns of the Latin American indices and the S&P index after the financial crisis. This kind of convergence might be a positive sign to accelerate the integration process in Latin America stock markets, which has had a slow development since its beginning a few years ago. |
| Keywords: | Dynamic Linear Models; Latin American Stock Markets |
| JEL: | G01 G15 |
| Date: | 2013–11–06 |
| URL: | http://d.repec.org/n?u=RePEc:col:000122:010931&r=fmk |
| By: | Marco Morales; Carola Moreno; Camilo Vio |
| Abstract: | The domestic impact of external shocks will depend on the degree of coupling of domestic assets to foreign markets, but also on the spillovers among assets. The covariance between different types of assets could be affected by the new information. Changes in the covariance could come from a stronger rebalancing between stocks and bonds. Therefore, we will analyze four different assets – government bonds, corporate bonds, money market instruments and equity – and study the conditional correlation between them. We find that the corporate bond market tends to increase coupling in turbulent times, while money market decreases. We propose to test international spillovers taking into account a methodology for estimating the conditional mean, variance and covariance on domestic bond and equity markets, while considering that shocks may have asymmetric effects depending if the news are good or bad. |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:chb:bcchwp:724&r=fmk |