nep-fmk New Economics Papers
on Financial Markets
Issue of 2014‒12‒03
thirteen papers chosen by

  1. The effect of G20 summits on global financial markets By Lo Duca, Marco; Stracca, Livio
  2. The Intrinsic Bounds of Risk Premium in the Markovian Consumption-Based CAPM By Jihun Han; Hyungbin Park
  3. Estimating heterogeneous agents behavior with different investment horizons in stock markets By Chen, Zhenxi
  4. How Does the Market Variance Risk Premium Vary over Time? Evidence from S&P 500 Variance Swap Investment Returns By Eirini Konstantinidi; George Skiadopoulos
  5. London Calling: Nonlinear Mean Reversion across National Stock Markets By Hyeongwoo Kim; Jintae Kim
  6. The VIX, the variance premium and stock market volatility By Bekaert, Geert; Hoerova, Marie
  7. Realizing stock market crashes: stochastic cusp catastrophe model of returns under time-varying volatility By Baruník, Jozef; Kukacka, Jiri
  8. Testing for Leverage Effect in Financial Returns By Christophe Chorro; Dominique Guegan; Florian Ielpo; Hanjarivo Lalaharison
  9. The Interplay between Public and Private Information in Asset Markets: Theoretical and Experimental Approaches By Alfarano, Simone; Camacho, Eva; Petrovic, Marko; Provenzano, Giulia
  10. The Bond Market: An Inflation-Targeter's Best Friend By Andrew K. Rose
  11. Prices, Debt and Market Structure in an Agent-Based Model of the Financial Market By Fischer, Thomas; Riedler, Jesper
  12. Stress Testing Engineering: the real risk measurement? By Dominique Guegan; Bertrand Hassani
  13. Competition, performance and portfolio quality in microfinance markets By Kumar Kar, Ashim; Bali Swain, Ranjula

  1. By: Lo Duca, Marco; Stracca, Livio
    Abstract: In the wake of the global financial crisis, the G20 has become the most important forum of global governance and cooperation, largely replacing the once powerful G7. In this paper we run an event study to test whether G20 meetings at ministerial and Leaders level have had an impact on global financial markets. We focus on the period from 2007 to 2013, looking at equity returns, bond yields and measures of market risk such as implied volatility, skewness and kurtosis. Our main finding is that G20 summits have not had a strong, consistent and durable effect on any of the markets that we consider, suggesting that the information and decision content of G20 summits is of limited relevance for market participants. JEL Classification: G14, G15, F53
    Keywords: event studies, financial crisis, G20, global financial markets, global governance, volatility
    Date: 2014–04
  2. By: Jihun Han; Hyungbin Park
    Abstract: Risk premium is one of main concepts in mathematical finance. It is a measure of the trade-offs investors make between return and risk and is defined by the excess return over the risk-free interest rate earned per one unit of risk of an asset. The purpose of this article is to find the upper and lower bounds of the risk premium of an asset based on the prices of options in the market. One of key assumptions to achieve this is that the market is Markovian. Under this assumption, we can transform the problem into a problem of a second-order differential equation and then obtain the upper and lower bounds by analyzing the differential equation.
    Date: 2014–11
  3. By: Chen, Zhenxi
    Abstract: In addition to the traditional agent types of fundamentalists and chartists, a new dimension of investment horizon is included in evaluating historical performance of strategies. Based on the three stock markets of Japan, Hong Kong and Germany, it is found that investors with different investment horizons exist in al the markets. Regressions based on all the investment horizons produce better fitted results. Different markets can be characterized by different agents and different investment horizons. Ignorance of the heterogeneity of investment horizon may generate biased results due to the concern of omitting variables.
    Keywords: Investment horizon,Heterogeneous agents,Evolutionary selection,Behavioral finance
    JEL: G12 C22
    Date: 2014
  4. By: Eirini Konstantinidi (University of Manchester); George Skiadopoulos (Queen Mary University of London University of Piraeus)
    Abstract: We explore whether the market variance risk premium (VRP) can be predicted. First, we propose a novel approach to measure VRP which distinguishes the investment horizon from the variance swap's maturity. We extract VRP from actual rather than synthetic S&P 500 variance swap quotes, thus avoiding biases in VRP measurement. Next, we find that a deterioration of the economy and of the trading activity, increases VRP. These relations hold both in- and out-of-sample for various maturities and investment horizons and they are economically significant. Volatility trading strategies which condition on the detected relations outperform popular buy-and-hold strategies even after transaction costs are considered.
    Keywords: Economic conditions, Predictability, Trading activity, Variance swaps, Variance risk premium, Volatility trading
    JEL: G13 G17
    Date: 2014–10
  5. By: Hyeongwoo Kim; Jintae Kim
    Abstract: This paper revisits empirical evidence of mean reversion of relative stock prices in international stock markets. We implement a strand of univariate and panel unit root tests for linear and nonlinear models of 18 national stock indices during the period 1969 to 2012. Our major findings are as follows. First, we find little evidence of linear mean reversion irrespective of the choice of a reference country. Employing panel tests yields the same conclusion once the cross-section dependence is controlled. Second, we find strong evidence of nonlinear mean reversion when the UK serves as a reference country, calling attention to the stock index in the UK. Choosing the US as a reference yields very weak evidence of nonlinear stationarity. Third, via extensive Monte Carlo simulations, we demonstrate a potential pitfall in using panel unit root tests with cross-section dependence when a stationary common factor dominates nonstationary idiosyncratic components in small samples.
    Keywords: Unit Root Test; Exponential Smooth Transition Autoregressive (ESTAR) Unit Root Test; Nonlinear Panel unit root test; Panel Analysis of Nonstationarity in Idiosyncratic and Common Components (PANIC)
    JEL: C22 G10 G15
    Date: 2014–11
  6. By: Bekaert, Geert; Hoerova, Marie
    Abstract: We decompose the squared VIX index, derived from US S&P500; options prices, into the conditional variance of stock returns and the equity variance premium. We evaluate a plethora of state-of-the-art volatility forecasting models to produce an accurate measure of the conditional variance. We then examine the predictive power of the VIX and its two components for stock market returns, economic activity and financial instability. The variance premium predicts stock returns while the conditional stock market variance predicts economic activity and has a relatively higher predictive power for financial instability than does the variance premium. JEL Classification: C22, C52, G12, E32
    Keywords: economic uncertainty, financial instability, option implied volatility, realized volatility, risk aversion, risk-return trade-off, stock return predictability, variance risk premium, VIX
    Date: 2014–05
  7. By: Baruník, Jozef; Kukacka, Jiri
    Abstract: This paper develops a two-step estimation methodology that allows us to apply catastrophe theory to stock market returns with time-varying volatility and to model stock market crashes. In the first step, we utilize high-frequency data to estimate daily realized volatility from returns. Then, we use stochastic cusp catastrophe on data normalized by the estimated volatility in the second step to study possible discontinuities in the markets. We support our methodology through simulations in which we discuss the importance of stochastic noise and volatility in a deterministic cusp catastrophe model. The methodology is empirically tested on nearly 27 years of U.S. stock market returns covering several important recessions and crisis periods. While we find that the stock markets showed signs of bifurcation in the first half of the period, catastrophe theory was not able to confirm this behavior in the second half. Translating the results, we find that the U.S. stock market's downturns were more likely to be driven by the endogenous market forces during the first half of the studied period, while during the second half of the period, the exogenous forces seem to be driving the market's instability. The results suggest that the proposed methodology provides an important shift in the application of catastrophe theory to stock markets.
    Keywords: stochastic cusp catastrophe model,realized volatility,bifurcations,stock market crash
    Date: 2014
  8. By: Christophe Chorro (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne); Dominique Guegan (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne); Florian Ielpo (Lombard Odier - Lombard Odier Darier Hentsch & Cie); Hanjarivo Lalaharison (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne)
    Abstract: This article questions the empirical usefulness of leverage effects to describe the dynamics of equity returns. Using a recursive estimation scheme that accurately disentangles the asymmetry coming from the conditional distribution of returns and the asymmetry that is related to the past return to volatility component in GARCH models, we test for the statistical significance of the latter. Relying on both in and out of sample tests we consistently find a weak contribution of leverage effect over the past 25 years of S&P 500 returns, casting light on the importance of the conditional distribution in time series models.
    Keywords: Maximum likelihood method; related-GARCH process; recursive estimation method; mixture of Gaussian distributions; Generalized hyperbolic distributions; S&P 500; forecast; leverage effect
    Date: 2014–02
  9. By: Alfarano, Simone; Camacho, Eva; Petrovic, Marko; Provenzano, Giulia
    Abstract: In this paper we will give an overview of the more relevant results on the theoretical and experimental research related to public and private information dissemination and aggregation in asset markets, focusing mainly on the contemporaneous presence of public and private information and its effect on market performance. We conclude that the theoretical literature is more developed than the experimental one when dealing with public information and its role in different economic environments. Therefore, a promising research avenue opens for experimentally testing the different, and often contradictory, theoretical results.
    Keywords: experiments,financial markets,private and public information,central bank information
    JEL: C92 D82 G14
    Date: 2014
  10. By: Andrew K. Rose
    Abstract: This paper explores the relationship between inflation and the existence of a publicly-traded, long-maturity, nominal, domestic-currency bond market. Bond holders suffer from inflation and could be a potent anti-inflationary force; I ask whether their presence is apparent empirically. I use a panel data approach, examining the difference in inflation before and after the introduction of a bond market. My primary focus is on countries with inflation targeting regimes, though I also examine countries with hard fixed exchange rates and other monetary regimes. Inflation-targeting countries with a bond market experience inflation approximately three to four percentage points lower than those without a bond market. This effect is economically and statistically significant; it is also insensitive to a variety of estimation strategies, including using political and fiscal instrumental variables. The existence of a bond market has little effect on inflation in other monetary regimes, as do indexed or foreign-denominated bonds.
    JEL: E52 E58
    Date: 2014–09
  11. By: Fischer, Thomas; Riedler, Jesper
    Abstract: We develop an agent-based model in which heterogeneous and boundedly rational agents interact by trading a risky asset at an endogenously set price. Agents are endowed with balance sheets comprising the risky asset as well as cash on the asset side and equity capital as well as debt on the liabilities side. A number of findings emerge when simulating the model: We find that the empirically observable log-normal distribution of bank balance sheet size naturally emerges and that higher levels of leverage lead to a greater inequality among agents. Furthermore, greater leverage increases the frequency of bankruptcies and systemic events. Credit frictions, which we define as the stickiness of debt adjustments, are able to explain a key difference in the relation between leverage and assets observed for different bank types. Lowering credit frictions leads to an increasingly pro-cyclical behavior of leverage, which is typical for investment banks. Nevertheless, the impact of credit frictions on the fragility of the model financial system is complex. Lower frictions do increase the stability of the system most of the time, while systemic events become more probable. In particular, we observe an increasing frequency of severe liquidity crises that can lead to the collapse of the entire model financial system.
    Keywords: agent-based model,financial markets,leverage,systemic risk,credit frictions
    JEL: C63 D53 D84
    Date: 2014
  12. By: Dominique Guegan (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne); Bertrand Hassani (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne)
    Abstract: Stress testing is used to determine the stability or the resilience of a given financial institution by deliberately submitting. In this paper, we focus on what may lead a bank to fail and how its resilience can be measured. Two families of triggers are analysed: the first stands in the stands in the impact of external (and / or extreme) events, the second one stands on the impacts of the choice of inadequate models for predictions or risks measurement; more precisely on models becoming inadequate with time because of not being sufficiently flexible to adapt themselves to dynamical changes.
    Keywords: Stress test; risk; VaR
    Date: 2014–02
  13. By: Kumar Kar, Ashim (Helsinki Center of Economic Research (HECER)); Bali Swain, Ranjula (Department of Economics)
    Abstract: In recent years growing competition in the microfinance industry has been censured for multiple borrowing, default crises, high interest rates and coercive recovery of loans. Using the Boone indicator as a measure for competition, our paper investigates the impact of competition on microfinance institutions’ (MFIs) outreach, financial performance and quality of loan portfolio. We deal with the potential endogeneity issues by employing the instrumental variable approach using the generalized methods of moments (GMM) estimation technique. Analysing the Microfinance Information Exchange data our empirical results show that increased competition in microfinance sector leads to a larger average loans and a decrease in the financial self-sustainability. The data also supports the view that increased competition in the microfinance industry leads to a decline in the loan portfolio quality.
    Keywords: microfinance institutions; competition; outreach; financial performance; capitalization; panel data IV estimation
    JEL: G21 G32
    Date: 2014–10–31

General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.