nep-fmk New Economics Papers
on Financial Markets
Issue of 2015‒05‒30
five papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Legal Risk Premia During the Euro-Crisis: The Role of Credit and Redenomination Risk By Nordvig, Jens
  2. Variance Premium and Implied Volatility in a Low-Liquidity Option Market By Eduardo Astorino; Fernando Chague, Bruno Cara Giovannetti, Marcos Eugênio da Silva
  3. A Stochastic Dominance Approach to the Basel III Dilemma: Expected Shortfall or VaR? By Chia-Lin Chang; Juan-Ángel Jiménez-Martín; Esfandiar Maasoumi; Michael McAleer; Teodosio Pérez-Amaral
  4. Ambiguity in Securitization Markets By Anderson, Alyssa G.
  5. Are SRI funds conventional funds in disguise or do they live up to their name? By Nitsche, Christin; Schröder, Michael

  1. By: Nordvig, Jens (Nomura Securities International, Inc.)
    Abstract: Using several new datasets, I document the role of legal risk premia in bond yields during the Euro-crisis. I find evidence of a rising premium especially in late 2011 and mid-2012 on bonds with foreign governing law relative to those with local governing law (and otherwise similar characteristics). The results illustrate that legal risk premia spiked at the height of the crisis in the Eurozone, when investors were willing to pay a premium for the additional protection offered by foreign law bonds. I show that this governing law premium can be linked to both credit risk (expected haircuts) and redenomination risk (expected currency depreciation). This paper is the first to empirically link the governing law premium to redenomination risk. I find evidence that redenomination risk is an independent driving force of governing law spreads over and above credit risk, although it is analytically challenging to separate the two risk factors. My findings, while not conclusive, are consistent with the consensus in the literature on contract law, which argues that local law financial instruments should be more susceptible to redenomination in a scenario of a country exiting the Eurozone.
    Keywords: General financial markets; International finance; Foreign exchange; Contract law; Financial econometrics; Financial crisis
    JEL: C58 F30 F31 G01 G10 K20
    Date: 2015–05–21
  2. By: Eduardo Astorino; Fernando Chague, Bruno Cara Giovannetti, Marcos Eugênio da Silva
    Abstract: We propose an implied volatility index for Brazil that we name "IVol-BR". The index is based on daily market prices of options over IBOVESPA -- an option market with relatively low liquidity and few option strikes. Our methodology combines standard international methodology used in high-liquidity markets with adjustments that take into account the low liquidity in Brazilian option markets. We then do a number of empirical tests to validate the IVol-BR. First, we show that the IVol-BR has significant predictive power over future volatility of equity returns not contained in traditional volatility forecasting variables. Second, we decompose the squared IVol-BR into (i) the expected variance of stock returns and (ii) the equity variance premium. This decomposition is of interest since the equity variance premium directly relates to the representative investor risk aversion. Finally, assuming Bollerslev et al. (2009) functional form, we produce a time-varying risk aversion measure for the Brazilian investor. We empirically show that risk aversion is positively related to expected returns, as theory suggests.
    Keywords: IVol-BR; Variance Risk Premium; Risk-aversion
    JEL: G12 G13 G17
    Date: 2015–05–18
  3. By: Chia-Lin Chang (National Chung Hsing University, Taichung, Taiwan); Juan-Ángel Jiménez-Martín (Complutense University of Madrid, Spain); Esfandiar Maasoumi (Emory University, United States); Michael McAleer (National Tsing Hua University, Taiwan, Erasmus School of Economics, Erasmus University Rotterdam,Tinbergen Institute, The Netherlands, Complutense University of Madrid, Spain); Teodosio Pérez-Amaral (Complutense University of Madrid, Spain)
    Abstract: The Basel Committee on Banking Supervision (BCBS) (2013) recently proposed shifting the quantitative risk metrics system from Value-at-Risk (VaR) to Expected Shortfall (ES). The BCBS (2013) noted that “a number of weaknesses have been identified with using VaR for determining regulatory capital requirements, including its inability to capture tail risk” (p. 3). For this reason, the Basel Committee is considering the use of ES, which is a coherent risk measure and has already become common in the insurance industry, though not yet in the banking industry. While ES is mathematically superior to VaR in that it does not show “tail risk” and is a coherent risk measure in being subadditive, its practical implementation and large calculation requirements may pose operational challenges to financial firms. Moreover, previous empirical findings based only on means and standard deviations suggested that VaR and ES were very similar in most practical cases, while ES could be less precise because of its larger variance. In this paper we find that ES is computationally feasible using personal computers and, contrary to previous research, it is shown that there is a stochastic difference between the 97.5% ES and 99% VaR. In the Gaussian case, they are similar but not equal, while in other cases they can differ substantially: in fat-tailed conditional distributions, on the one hand, 97.5%-ES would imply higher risk forecasts, while on the other, it provides a smaller down-side risk than using the 99%-VaR. It is found that the empirical results in the paper generally support the proposals of the Basel Committee.
    Keywords: Stochastic dominance; Value-at-Risk; Expected Shortfall; Optimizing strategy; Basel III Accord
    JEL: C53 C22 G32 G11 G17
    Date: 2015–05–18
  4. By: Anderson, Alyssa G. (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: During the financial crisis of 2008, origination and trading in asset-backed securities markets dropped dramatically. I present a model with ambiguity averse investors to explain how such a market freeze could occur and to investigate how ambiguity affects origination and securitization decisions. The model captures many features of the crisis, including market freezes and fire sales, as well as the timing and duration of the freeze. The presence of ambiguity also reduces real economic activity. Lastly, I consider the differing implications of ambiguity and risk, as well as the role of policies that reduce ambiguity during market freezes.
    Keywords: Structured finance; ambiguity aversion; market freezes
    JEL: E44 G01 G21 G28
    Date: 2015–05–13
  5. By: Nitsche, Christin; Schröder, Michael
    Abstract: In recent years, the socially responsible investing (SRI) industry has become an important segment of international capital markets by incorporating ESG (Environmental, Social and Governance) factors into investment selection and management processes. This study analyses whether SRI mutual funds are conventional funds in disguise or invest in line with their ESG objectives. In contrast to other studies, the analysis exclusively focuses on the non-financial performance of SRI vis-à-vis conventional funds and applies ESG corporate ratings of three rating agencies (Oekom, Sustainalytics and ASSET4) to a European and global fund universe. The SRI and non-SRI funds are analyzed with respect to differences in their Top 10 fund holdings, their average ESG rankings and the significance of rating differences by utilizing cross-sectional regressions. At a first glance, the top holdings of both fund types seem very similar, but the results of the ranking analysis show that SRI funds have on average higher ESG rankings. Additionally, the cross-sectional regressions show that the ESG rating differences between SRI funds and conventional funds are significantly positive, i.e. SRI funds exhibit higher ESG ratings than conventional funds. These findings are robust as they hold for every single ESG factor and total scores and as well as across the different ratings applied.
    Keywords: Mutual funds,socially responsible investments,ESG performance,ESG ratings
    JEL: G11 G23 G24 M14
    Date: 2015

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