nep-fmk New Economics Papers
on Financial Markets
Issue of 2014‒11‒01
two papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Communication impacting financial markets By Jorgen Vitting Andersen; Ioannis Vrontos; Petros Dellaportas; Serge Galam
  2. An Industrial Organization Approach to International Portfolio Diversification: Evidence from the U.S. Mutual Fund Families By Shin, Chae Hee

  1. By: Jorgen Vitting Andersen; Ioannis Vrontos; Petros Dellaportas; Serge Galam
    Abstract: 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. 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. 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.
    Date: 2014–10
  2. By: Shin, Chae Hee (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: Although the lack of international portfolio diversification has long interested the financial economics literature, the role of financial intermediaries in the market for diversified portfolios has rarely been studied. In this paper, I introduce a microeconomic aspect of under-diversification by examining a new data on U.S.-based mutual fund families' global diversification. I document the fund families' investments in global equity markets and explore features of supply and demand in the mutual fund market to explain their limited global diversification. Demand estimation confirms that consumers are not only sensitive to the fund families' portfolio characteristics such as global diversification, but also to the non-portfolio characteristics such as fund family age and size. On the supply side, the model of fund families' global investment decisions uses a revealed preference approach and shows small cross-border investment frictions can justify the fund families' observed limited global diversification. Other factors such as destination country's investor protection level and fund family's investment experience significantly affect the degree of diversification as well.
    Keywords: Diversification; mutual funds
    Date: 2014–09–17

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