nep-fmk New Economics Papers
on Financial Markets
Issue of 2015‒09‒05
twelve papers chosen by

  1. Stock Market Investment: The Role of Human Capital By Athreya, Kartik B.; Ionescu, Felicia; Neelakantan, Urvi
  2. Time-dependent scaling patterns in high frequency financial data By Noemi Nava; Tiziana Di Matteo; Tomaso Aste
  3. Tri-Party Repo Pricing By Grace Xing Hu; Jun Pan; Jiang Wang
  4. Tick Size: Theory and Evidence By Werner, Ingrid M.; Wen, Yuanji; Rindi, Barbara; Consonni, Francesco; Buti, Sabrina
  5. Endogenous Formation of Limit Order Books: the Effects of Trading Frequency By Roman Gayduk; Sergey Nadtochiy
  6. Mutual fund investment horizon and performance By Lan, Chunhua; Moneta, Fabio; Wermers, Russ
  7. Do Private Equity Funds Benefit from their Relationships with Financial Advisors in M&A Transactions? By Morkoetter, Stefan; Wetzer, Thomas
  8. The effect of stock market indexing on corporate tax avoidance By Alex Young
  9. Rethinking Financial Regulation: How Confusions Have Prevented Progress By Admati, Anat R.
  10. Prestige without Purpose? Reputation, Differentiation, and Pricing in U.S. Equity Underwriting By Fernando, Chitru S.; Gatchev, Vladimir A.; May, Anthony D.; Megginson, William L.
  11. Early warning of large volatilities based on recurrence interval analysis in Chinese stock markets By Zhi-Qiang Jiang; Askery A. Canabarro; Boris Podobnik; H. Eugene Stanley; Wei-Xing Zhou
  12. Automatic model selection for forecasting Brazilian stock returns By CUNHA, Ronan; VALLS PEREIRA, Pedro L.

  1. By: Athreya, Kartik B. (Federal Reserve Bank of Richmond); Ionescu, Felicia (Board of Governors of the Federal Reserve System (U.S.)); Neelakantan, Urvi (Federal Reserve Bank of Richmond)
    Abstract: Portfolio choice models counterfactually predict (or advise) almost universal equity market participation and a high share for equity in wealth early in life. Empirically consistent predictions have proved elusive without participation costs, informational frictions, or nonstandard preferences. We demonstrate that once human capital investment is allowed, standard theory predicts portfolio choices much closer to those empirically observed. Two intuitive mechanisms are at work: For participation, human capital returns exceed ?nancial asset returns for most young households and, as households age, this is reversed. For shares, risks to human capital limit the household's desire to hold wealth in risky ?nancial equity.
    Keywords: Human capital investment; life-cycle; financial portfolios
    JEL: E21 G11 J24
    Date: 2015–06–14
  2. By: Noemi Nava; Tiziana Di Matteo; Tomaso Aste
    Abstract: We measure the influence of different time-scales on the dynamics of financial market data. This is obtained by decomposing financial time series into simple oscillations associated with distinct time-scales. We propose two new time-varying measures: 1) an amplitude scaling exponent and 2) an entropy like measure. We apply these measures to intra-day, 30-second sampled prices of various stock indices. Our results reveal intra-day trends where different time-horizons contribute with variable relative amplitudes over the course of the trading day. Our findings indicate that the time series we analysed have a non-stationary multi-fractional nature with predominantly persistent behaviour at the middle of the trading session and anti-persistent behaviour at the open and close. We demonstrate that these deviations are statistically significant and robust.
    Date: 2015–08
  3. By: Grace Xing Hu; Jun Pan; Jiang Wang
    Abstract: In this paper, we examine the pricing determinants in the systemically important tri-party repo market. Taking advantage of the recently available N-MFP reports filed by money market funds, we construct a novel dataset that contains tri-party repo transactions between money market funds and dealer banks. We find a large cross-sectional heterogeneity in repo pricing, reflected most significantly in the haircuts of repos backed by equity and corporate bonds. Surprisingly, it is the fund families, not bank dealers, who are the dominant factor in determining the pricing. Moreover, the repo market exhibits significant segmentation, with fund families adopting three different pricing schemes: counter-party sensitive, counter-party and collateral sensitive, and uniform. Most fund families use uniform haircuts by fixing a constant haircut, which itself varies across families, for all repos within each asset class, regardless of the quality of collateral or counter-party. Investigating further on the lending/borrowing relationship between fund families and dealers, we find that, when faced with such a rich pricing pattern, dealers do not shop around for a better haircut and are inclined to maintain a stable relationship with their lenders. Finally, for repos backed by Treasury securities, there is little variation in both haircuts and spreads, regardless of the fund family.
    JEL: G1 G12
    Date: 2015–08
  4. By: Werner, Ingrid M. (OH State University); Wen, Yuanji (University of Western Australia); Rindi, Barbara (Bocconi University); Consonni, Francesco (Bocconi University); Buti, Sabrina (University of Toronto)
    Abstract: We model a public limit order book where rational traders decide whether to demand or supply liquidity, and where liquidity builds endogenously. The model predicts that a reduction of the tick size will cause spreads and welfare to deteriorate for illiquid but improve for liquid books. We find empirical support for these predictions based on European and U.S. data. The model also generates predictions for volume, but we find less empirical support for these predictions which we attribute to opportunistic High-Frequency-Traders selectively entering the market.
    JEL: G10 G12 G14 G18 G20
    Date: 2015–03
  5. By: Roman Gayduk; Sergey Nadtochiy
    Abstract: In this work, we present a modeling framework in which the shape and dynamics of a Limit Order Book (LOB) arise endogenously from an equilibrium between multiple market participants (agents). On the one hand, the new framework captures very closely the true, micro-level, mechanics of an auction-style exchange. On the other hand, it uses the standard abstractions of games with continuum of players (in particular, the mean field game theory) to obtain a tractable macro-level description of the LOB. We use the proposed modeling framework to analyze the effects of trading frequency on the liquidity of the market in a very general setting. In particular, we show that the higher trading frequency increases market efficiency if the agents choose to provide liquidity in equilibrium. However, we also show that the higher trading frequency makes markets more fragile, in the following sense: in a high-frequency trading regime, the agents choose to provide liquidity in equilibrium if and only if they are market-neutral (i.e. their beliefs satisfy certain martingale property). The theoretical results are illustrated with numerical examples.
    Date: 2015–08
  6. By: Lan, Chunhua; Moneta, Fabio; Wermers, Russ
    Abstract: This paper proposes several new holdings-based measures of fund investment horizon, and examines the relation between manager skills and fund holding horizon. We find that both aggregate holdings and trades of long-horizon funds are informative about superior future long-term stock returns, whereas aggregate trades, but not holdings, of short-horizon funds are associated with future short-term stock returns. Specifically, stocks that are largely held by long-term funds outperform stocks that are largely held by short-term funds by roughly 3% per year over the following five-year period. This superior performance of fund managers with long investment horizons stems from their ability to identify superior long-term firm fundamentals. In contrast, short-term funds predict short-term earnings or use simple mechanical strategies, such as momentum strategies, to select stocks.
    Keywords: mutual funds,performance evaluation,investment horizons,selection skills
    JEL: G11 G23
    Date: 2015
  7. By: Morkoetter, Stefan; Wetzer, Thomas
    Abstract: We link acquirer-advisor relationship information of 53,552 M&A transactions with pricing information of 11,438 deals and show that private equity funds pay, on average, less for their portfolio companies when target advisors have worked for them on the buy-side in past transactions. This effect is mainly driven by larger PE firms with a high level of deal activity and increases with the number of past buy-side transactions. Strategic acquirers do not benefit from these previous relationships. Close relationships with their own financial advisors in turn do not pay-off for both strategic and PE-related acquirers.
    Keywords: Private Equity, Mergers and Acquisitions, Financial Advisors, Take-over Premiums
    JEL: G15 G24 G32 G34
    Date: 2015–08
  8. By: Alex Young
    Abstract: Membership in the Russell 1000 and 2000 Indices is based on a ranking of market capitalization in May. Each index is separately value weighted such that firms just inside the Russell 2000 are comparable in size to firms just outside (i.e. at the bottom of the Russell 1000) but have much higher index weights. These features allow for the the annual reconstitution of these indices to be used as part of a regression discontinuity design to identify the effect of stock market indexing. Using this design, I investigate whether stock market indexing affects corporate tax avoidance. I find no evidence that firms just inside the Russell 2000 have significantly different effective tax rates than firms just outside.
    Date: 2015–09
  9. By: Admati, Anat R. (Stanford University)
    Abstract: Flawed and ineffective financial regulation fails to counter, and may exacerbate, distorted incentives within the financial system. The forces that lead to excessive fragility through unnecessary and dangerous levels of leverage, opacity, complexity and interconnectedness also distort credit markets and create other inefficiencies. In this chapter I focus on the failure to correct key flaws, which were evident in 2007-2009, in the design and implementation of capital regulations. These flaws include low equity levels, the risk-weighting system, allowing debt-like hybrids (under various titles, such as Total Loss Absorbing Capacity or TLACs) as substitutes for equity, and measurement issues, including poor accounting of risk exposures in derivatives markets and in the so-called shadow banking system. Confusions about the sources of the problems and about the tradeoffs associated with specific tools have muddled the policy debate and have allowed narrow interests and political forces to derail progress towards a safer and healthier financial system.
    Date: 2015–06
  10. By: Fernando, Chitru S. (University of OK); Gatchev, Vladimir A. (University of Central FL); May, Anthony D. (Wichita State University); Megginson, William L. (University of OK)
    Abstract: Clustering of IPO underwriting spreads at 7% poses two important puzzles: Is the market for U.S. equity underwriting services anti-competitive and why do equity underwriters invest in reputation-building? This study helps resolve both puzzles. Modeling endogeneity of firm-underwriter choice using a two-sided matching approach, we provide strong evidence of price and service differentiation based on underwriter reputation. High-reputation banks receive average reputational premia equaling 0.65% (0.47%) of average IPO (SEO) underwritten proceeds, which constitutes 10% (13%) of their underwriting spreads. Equity issuers working with high-reputation underwriters receive significant benefits, including higher offer values and lower percentage spreads net of reputational premia.
    JEL: G24 G32 L14 L15
    Date: 2015–06
  11. By: Zhi-Qiang Jiang (ECUST, BU); Askery A. Canabarro (UFAL, BU); Boris Podobnik (UR); H. Eugene Stanley (BU); Wei-Xing Zhou (ECUST)
    Abstract: Being able to forcast extreme volatility is a central issue in financial risk management. We present a large volatility predicting method based on the distribution of recurrence intervals between volatilities exceeding a certain threshold $Q$ for a fixed expected recurrence time $\tau_Q$. We find that the recurrence intervals are well approximated by the $q$-exponential distribution for all stocks and all $\tau_Q$ values. Thus a analytical formula for determining the hazard probability $W(\Delta t |t)$ that a volatility above $Q$ will occur within a short interval $\Delta t$ if the last volatility exceeding $Q$ happened $t$ periods ago can be directly derived from the $q$-exponential distribution, which is found to be in good agreement with the empirical hazard probability from real stock data. Using these results, we adopt a decision-making algorithm for triggering the alarm of the occurrence of the next volatility above $Q$ based on the hazard probability. Using a "receiver operator characteristic" (ROC) analysis, we find that this predicting method efficiently forecasts the occurrance of large volatility events in real stock data. Our analysis may help us better understand reoccurring large volatilities and more accurately quantify financial risks in stock markets.
    Date: 2015–08
  12. By: CUNHA, Ronan; VALLS PEREIRA, Pedro L.
    Abstract: This study aims to contribute on the forecasting literature in stock return for emerging markets. We use Autometrics to select relevant predictors among macroeconomic, microeconomic and technical variables. We develop predictive models for the Brazilian market premium, measured as the excess return over Selic interest rate, Itaú SA, Itaú-Unibanco and Bradesco stock returns. We find that for the market premium, an ADL with error correction is able to outperform the benchmarks in terms of economic performance. For individual stock returns, there is a trade o between statistical properties and out-of-sample performance of the model.
    Date: 2015–08–07

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