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on Financial Markets |
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Issue of 2014‒12‒08
ten papers chosen by |
| By: | Barunik, Jozef; Kočenda, Evžen; Vácha, Lukáš |
| Abstract: | Asymmetries in volatility spillovers are highly relevant to risk valuation and portfolio diversification strategies in financial markets. Yet, the large literature studying information transmission mechanisms ignores the fact that bad and good volatility may spill over at different magnitudes. This paper fills this gap with two contributions. One, we suggest how to quantify asymmetries in volatility spillovers due to bad and good volatility. Two, using high frequency data covering most liquid U.S. stocks in seven sectors, we provide ample evidence of the asymmetric connectedness of stocks. We universally reject the hypothesis of symmetric connectedness at the disaggregate level but in contrast, we document the symmetric transmission of information in an aggregated portfolio. We show that bad and good volatility is transmitted at different magnitudes in different sectors, and the asymmetries sizably change over time. While negative spillovers are often of substantial magnitudes, they do not strictly dominate positive spillovers. We find that the overall intra-market connectedness of U.S. stocks increased substantially with the increased uncertainty of stock market participants during the financial crisis. |
| Keywords: | volatility,spillovers,semivariance,asymmetric effects,financial markets |
| JEL: | C18 C58 G15 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:fmpwps:13&r=fmk |
| By: | Georg, Co-Pierre |
| Abstract: | When banks choose similar investment strategies, the financial system becomes vulnerable to common shocks. Banks decide about their investment strategy ex-ante based on a private belief about the state of the world and a social belief formed from observing the actions of peers. When the social belief is strong and the financial network is fragmented, banks follow their peers and their investment strategies synchronize. This effect is stronger for less informative private signals. For endogenously formed interbank networks, however, less informative signals lead to higher network density and less synchronization. It is shown that the former effect dominates the latter. JEL Classification: G21, C73, D53, D85 |
| Keywords: | endogenous nancial networks, multi-agent simulations, social learning, Systemic risk |
| Date: | 2014–07 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20141700&r=fmk |
| By: | Makoto Nirei (Hitotsubashi University); Tsutomu Watanabe (The University of Tokyo) |
| Abstract: | Using a simultaneous-move herding model of rational traders who infer other traders' private information on the value of an asset by observing their aggre- gate actions, this study seeks to explain the emergence of fat-tailed distributions of transaction volumes and asset returns in financial markets. Without mak- ing any parametric assumptions on private information, we analytically show that traders' aggregate actions follow a power law distribution. We also provide simulation results to show that our model successfully reproduces the empirical distributions of asset returns. We argue that our model is similar to Keynes's beauty contest in the sense that traders, who are assumed to be homogeneous, have an incentive to mimic the average trader, leading to a situation similar to the indeterminacy of equilibrium. In this situation, a trader's buying action causes a stochastic chain-reaction, resulting in power laws for financial fluctuations. |
| Date: | 2014–06 |
| URL: | http://d.repec.org/n?u=RePEc:cfi:fseres:cf346&r=fmk |
| By: | Jonathan B. Berk; Jules H. van Binsbergen |
| Abstract: | We propose a new method of testing asset pricing models that relies on using quantities rather than prices or returns. We use the capital flows into and out of mutual funds to infer which risk model investors use. We derive a simple test statistic that allows us to infer, from a set of candidate models, the model that is closest to the true risk model. Using this methodology, we find that of the models most commonly used in the literature, the Capital Asset Pricing Model is the closest. Given our current state of knowledge, the Capital Asset Pricing Model is thus the appropriate method to use to calculate the cost of capital of an investment opportunity. Despite the Capital Asset Pricing Model's success, we also document that a large fraction of mutual fund flows remain unexplained by existing asset pricing models. |
| JEL: | D14 D24 E2 E22 E44 G0 G00 G1 G10 G11 G12 G2 G20 G23 |
| Date: | 2014–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:20435&r=fmk |
| By: | Ales Bulir; Martin Cihak; David-Jan Jansen |
| Abstract: | We study whether clarity of central bank inflation reports affects return volatility in financial markets. We measure clarity of reports by the Czech National Bank, the European Central Bank, the Bank of England, and Sveriges Riksbank using the Flesch-Kincaid grade level, a standard readability measure. We find some evidence, mainly for the euro area, of a negative relationship between clarity and market volatility prior to and during the early stage of the global financial crisis. As the crisis unfolded, there is no longer robust evidence of a negative connection. We conclude that reducing noise using clear reports is possible but not without challenges, especially in times of crisis. |
| Keywords: | Inflation;Central banks;Public information;Capital market volatility;Financial markets;central bank communication, clarity, financial markets, inflation reports, volatility |
| Date: | 2014–09–24 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:14/175&r=fmk |
| By: | Aloosh, Arash |
| Abstract: | In a long-run risk model with stochastic volatility and frictionless markets, I express expected forex returns as a function of consumption growth variances and stock variance risk premiums (VRPs)—the difference between the risk-neutral and statistical expectations of market return variation. This provides a motivation for using the forward-looking information available in stock market volatility indices to predict forex returns. Empirically, I find that stock VRPs predict forex returns at a one-month horizon, both in-sample and out-of-sample. Moreover, compared to two major currency carry predictors, global VRP has more predictive power for currency carry trade returns, bilateral forex returns, and excess equity return differentials. |
| Keywords: | Global Variance Risk Premium; Excess Foreign Exchange (Forex) Return; Frictionless Markets; Predictability. |
| JEL: | F31 F37 G15 |
| Date: | 2014–11–19 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:59931&r=fmk |
| By: | Bertaut, Carol C. (Board of Governors of the Federal Reserve System (U.S.)); Tabova, Alexandra M. (Board of Governors of the Federal Reserve System (U.S.)); Wong, Vivian (Board of Governors of the Federal Reserve System (U.S.)) |
| Abstract: | The expansion in financial sector "safe" assets, largely in the form of structured products from the U.S. and the Caribbean, in the lead-up to the global financial crisis has by now been fairly well documented. Using a unique dataset derived from security-level data on U.S. portfolio holdings of foreign securities, we show that since the crisis, it is mostly the foreign financial sector that appears to have met U.S. demand for safe and liquid investment assets by expanding its supply of debt securities. We also find a strong negative correlation between the foreign share of the U.S. financial bond portfolio and measures of U.S. safe assets availability: providing evidence on the importance of foreign-issued financial sector debt as a substitute when U.S. issued "safe" assets are scarce. Furthermore, although U.S. investors continue to tap foreign financial markets for "safe" assets, we show that the type of foreign financial debt that fills this portfolio niche post-crisis is quite different than pre-crisis. Post-crisis, we find that U.S. investors have replaced offshore-issued structured securities with high-grade U.S. dollar-denominated financial debt issued from a small group of OECD countries (most notably Australia and Canada). Lastly, these developments have led to a decline in home bias in the U.S. financial bond portfolio that we are able to document for the first time. |
| Keywords: | safe assets; international portfolio choice; financial sector debt; home bias |
| JEL: | F21 F34 G11 G20 |
| Date: | 2014–10–30 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:1123&r=fmk |
| By: | Brent Glover; Seth Richards-Shubik |
| Abstract: | We use a network model of credit risk to measure market expectations of the potential spillovers from a sovereign default. Specifically, we develop an empirical model, based on the recent theoretical literature on contagion in financial networks, and estimate it with data on sovereign credit default swap spreads and the detailed structure of financial linkages among thirteen European sovereigns from 2005 to 2011. Simulations from the estimated model show that a sovereign default generates only small spillovers to other sovereigns. These results imply that credit markets do not demand a significant premium for the interconnectedness of sovereign debt in Europe. |
| JEL: | D85 F34 F36 G01 L14 |
| Date: | 2014–10 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:20567&r=fmk |
| By: | Dunne, Peter G. (Central Bank of Ireland); Fleming, Michael J. (Reserve Bank of New York); Zholos, Andrey (Barclays Capital) |
| Abstract: | We examine the relationship between monetary policy operations and interbank trading of funds using sovereign bonds as collateral. We first establish that, in the pre-crisis period, there are important but rather weak relations between these funding sources and that this relationship varies within maintenance periods and at the end of the year. Oficial funding conditions did not meaningfully constrain repo market activity in the 2003-05 period but, in the immediate pre-crisis period, rate increases led to a sharp contraction in repo activity. Focusing on the crisis period, we identify potentially benign substitution effects between official auctions and repo market activity but our empirical analysis shows that positive innovations in the cost of official funding, due to aggressive bidding, and a limited allotment response, encouraged increased use of the interbank repo market. The analysis informs a discussion of the merits of returning to variable rate operations. |
| Keywords: | Repo, Funding, Liquidity, Monetary Policy, Reserve Management. |
| JEL: | E43 E44 E52 E53 G12 G14 |
| Date: | 2014–08 |
| URL: | http://d.repec.org/n?u=RePEc:cbi:wpaper:09/rt/14&r=fmk |
| By: | Masaaki Fujii (The University of Tokyo); Akihiko Takahashi (The University of Tokyo) |
| Abstract: | All the financial practitioners are working in incomplete markets full of unhedgeable risk-factors. Making the situation worse, they are only equipped with the imperfect information on the relevant processes. In addition to the market risk, fund and insurance managers have to be prepared for sudden and possibly contagious changes in the investment flows from their clients so that they can avoid the over- as well as under-hedging. In this work, the prices of securities, the occurrences of insured events and (possibly a network of) the investment flows are used to infer their drifts and intensities by a stochastic filtering technique. We utilize the inferred information to provide the optimal hedging strategy based on the mean-variance (or quadratic) risk criterion. A BSDE approach allows a systematic derivation of the optimal strategy, which is shown to be implementable by a set of simple ODEs and the standard Monte Carlo simulation. The presented framework may also be useful for manufactures and energy firms to install an efficient overlay of dynamic hedging by financial derivatives to minimize the costs. |
| Date: | 2014–07 |
| URL: | http://d.repec.org/n?u=RePEc:cfi:fseres:cf348&r=fmk |