nep-fmk New Economics Papers
on Financial Markets
Issue of 2015‒10‒25
ten papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Downside Variance Risk Premium By Bruno Feunou; Mohammad R. Jahan-Parvar; Cédric Okou
  2. Asset Pricing with Horizon-Dependent Risk Aversion By Thomas Eisenbach; Martin Schmalz; Marianne Andries
  3. Anchoring Adjusted Capital Asset Pricing Model By Hammad, Siddiqi
  4. Detrended cross-correlations between returns, volatility, trading activity, and volume traded for the stock market companies By Rafal Rak; Stanislaw Drozdz; Jaroslaw Kwapien; Pawel Oswiecimka
  5. On the Interplay Between Speculative Bubbles and Productive Investment By Xavier Raurich; Thomas Seegmuller
  6. Predicting Stock Returns and Volatility with Investor Sentiment Indices: A Reconsideration using a Nonparametric Causality-in-Quantiles Test By Mehmet Balcilar; Rangan Gupta; Clement Kyei
  7. Equity Prices and Cartel Activity By Dan Richards; Heng Yuan; Marcelo Bianconi
  8. Credit Risk and Interdealer Networks By Or Shachar; Jennifer La'O; Anna Costello; Nina Boyarchenko
  9. Feasible earnings momentum in the U.S. stock market: An investor's perspective By Krauss, Christopher; Beerstecher, Daniel; Krüger, Tom
  10. Credit risk characteristics of US small business portfolios By Bams, Dennis; Pisa, Magdalena; Wolff, Christian C

  1. By: Bruno Feunou; Mohammad R. Jahan-Parvar; Cédric Okou
    Abstract: We decompose the variance risk premium into upside and downside variance risk premia. These components reflect market compensation for changes in good and bad uncertainties. Their difference is a measure of the skewness risk premium (SRP), which captures asymmetric views on favorable versus undesirable risks. Empirically, we establish that the downside variance risk premium (DVRP) is the main component of the variance risk premium. We find a positive and significant link between the DVRP and the equity premium, and a negative and significant relation between the SRP and the equity premium. A simple equilibrium consumption-based asset pricing model supports our decomposition.
    Keywords: Asset pricing
    JEL: G G1 G12
    Date: 2015
  2. By: Thomas Eisenbach (Federal Reserve Bank of New York); Martin Schmalz (University of Michigan); Marianne Andries (Toulouse School of Economics)
    Abstract: We study general equilibrium asset prices in a multi-period endowment economy when agents' risk aversion is allowed to depend on the maturity of the risk. In our pseudo-recursive preference framework, agents are time inconsistent for their intra- temporal decision making, though time consistent for inter-temporal decisions. We find, in the absence of jumps and under log-normal consumption growth, horizon- dependent risk aversion preferences affect the term structure of risk premia if and only if volatility is stochastic. When risk aversion decreases with the horizon (as lab experiments indicate), and the elasticity of intertemporal substitution is greater than one, our model results in a downward slopping (in absolute value) pricing of volatility risk, which, in turns, can explain the recent empirical results on the term structure of risky asset returns. We confirm this prediction using index options data.
    Date: 2015
  3. By: Hammad, Siddiqi
    Abstract: An anchoring adjusted Capital Asset Pricing Model (ACAPM) is developed in which the payoff volatilities of well-established stocks are used as starting points that are adjusted to form volatility judgments about other stocks. Anchoring heuristic implies that such adjustments are typically insufficient. ACAPM converges to CAPM with correct adjustment, so CAPM is a special case of ACAPM. The model provides a unified explanation for the size, value, and momentum effects in the stock market. A key prediction of the model is that the equity premium is larger than what can be justified by market volatility. Hence, anchoring also provides a potential explanation for the well-known equity premium puzzle. Anchoring approach predicts that stock splits are associated with positive abnormal returns and an increase in return volatility. The approach predicts that reverse stock-splits are associated with negative abnormal returns, and a fall in return volatility. Existing empirical evidence strongly supports these predictions.
    Keywords: Size Premium, Value Premium, Behavioral Finance, Stock Splits, Equity Premium Puzzle, Anchoring Heuristic, CAPM, Asset Pricing, Momentum Effect
    JEL: G02 G10 G11 G12
    Date: 2015–10–01
  4. By: Rafal Rak; Stanislaw Drozdz; Jaroslaw Kwapien; Pawel Oswiecimka
    Abstract: We consider a few quantities that characterize trading on a stock market in a fixed time interval: logarithmic returns, volatility, trading activity (i.e., the number of transactions), and volume traded. We search for the power-law cross-correlations among these quantities aggregated over different time units from 1 min to 10 min. Our study is based on empirical data from the American stock market consisting of tick-by-tick recordings of 31 stocks listed in Dow Jones Industrial Average during the years 2008-2011. Since all the considered quantities except the returns show strong daily patterns related to the variable trading activity in different parts of a day, which are the best evident in the autocorrelation function, we remove these patterns by detrending before we proceed further with our study. We apply the multifractal detrended cross-correlation analysis with sign preserving (MFCCA) and show that the strongest power-law cross-correlations exist between trading activity and volume traded, while the weakest ones exist (or even do not exist) between the returns and the remaining quantities. We also show that the strongest cross-correlations are carried by those parts of the signals that are characterized by large and medium variance. Our observation that the most convincing power-law cross-correlations occur between trading activity and volume traded reveals the existence of strong fractal-like coupling between these quantities.
    Date: 2015–10
  5. By: Xavier Raurich (Departament de Teoria Econòmica and CREB Universitat de Barcelona - Departament de Teoria Econòmica and CREB Universitat de Barcelona); Thomas Seegmuller (AMSE - Aix-Marseille School of Economics - EHESS - École des hautes études en sciences sociales - Centre national de la recherche scientifique (CNRS) - Ecole Centrale Marseille (ECM) - AMU - Aix-Marseille Université)
    Abstract: The aim of this paper is to study the interplay between long term productive investments and more short term and liquid speculative ones. A three-period lived overlapping generations model allows us to make this distinction. Agents have two investment decisions. When young, they can invest in productive capital that provides a return during the following two periods. When young or in the middle age, they can also invest in a bubble. Assuming, in accordance with the empirical evidence, that the bubbleless economy is dynamically efficient, the existence of a stationary bubble raises productive investment and production. Indeed, young agents sell short the bubble to increase productive investments, whereas traders at middle age transfer wealth to the old age. We outline that a technological change inducing either a larger return of capital in the short term or a similar increase in the return of capital in both periods raises productive capital, production and the bubble size. This framework also allows us to discuss several economic applications: the effects of both regulation on limited borrowing and fiscal policy on the occurrence of bubbles, the introduction of a probability of market crash and the effect of bubbles on income inequality.
    Keywords: bubble,efficiency,vintage capital,short sellers,overlapping generations
    Date: 2015–10
  6. By: Mehmet Balcilar (Department of Economics, Eastern Mediterranean University, Famagusta, via Mersin 10, Northern Cyprus, Turkey and Department of Economics, University of Pretoria); Rangan Gupta (Department of Economics, University of Pretoria); Clement Kyei (Department of Economics, University of Pretoria)
    Abstract: Evidence of monthly stock returns predictability based on popular investor sentiment indices, namely SBW and SPLS as introduced by Baker and Wurgler (2006, 2007) and Huang et al. (2015) respectively are mixed. While, linear predictive models show that only SPLS can predict excess stock returns, nonparametric models (which accounts for misspecification of the linear frameworks due to nonlinearity and regime changes) finds no evidence of predictability based on either of these two indices for not only stock returns, but also its volatility. However, in this paper, we show that when we use a more general nonparametric causality-in –quantiles model of Balcilar et al., (2015), in fact, both SBW and SPLS can predict stock returns and its volatility, with SPLS being a relatively stronger predictor of excess returns during bear and bull regimes, and SBW being a relatively powerful predictor of volatility of excess stock returns, barring the median of the conditional distribution.
    Keywords: Investor sentiment, stock markets, linear causality, nonlinear dependence, nonparametric causality, causality-in-quantiles
    JEL: C22 C32 C53 G02 G10 G11 G17
    Date: 2015–10
  7. By: Dan Richards; Heng Yuan; Marcelo Bianconi
    Abstract: We use an event study method to determine the impact of announced cartel activity on equity prices. Unlike prior research, we employ the Fama-French (1993) three-factor model to estimate normal event-window returns. The announcement that a firm is under investigation for price-fixing has a long-lasting negative impact on stock prices of nearly two percent in magnitude. This effect however seems to vanish for those firms receiving leniency for early confession. We further find that the extra profit lost from ending the cartel may plausibly explain the equity fall.
    Keywords: Event Study, Equity Prices, Cartels
    JEL: G14 L4
  8. By: Or Shachar (Federal Reserve Bank of New York); Jennifer La'O (Columbia University); Anna Costello (Massachusetts Institute of Technology); Nina Boyarchenko (Federal Reserve Bank of New York)
    Abstract: We study how bank holding companies interact in the corporate bond, syndicated loan, and credit default swap (CDS) markets. These three markets represent different ways to trade credit risk. The corporate bond market allows market participants to trade corporate credit risk directly. Similarly, the syndicated loan market allows direct exposure to corporate credit risk but is limited to only the largest borrowers and has lower secondary market liquidity. Finally, participants in the CDS market take an indirect exposure to the ultimate borrower. CDS markets are the most liquid of the three markets, allowing dealers to more easily assume long and short positions. Moreover, by entering into a CDS contract with another dealer, the firm also exposes itself to counterparty risk. This paper links data from these three different markets to create a more complete picture of how dealers assume and distribute credit risk. We identify key determinants of dealers' net and gross exposures to credit risk. We furthermore map out the interdealer network structures in these markets, allowing us to study how these network structures distribute risk among the dealers and how they shape the total risk borne by the system.
    Date: 2015
  9. By: Krauss, Christopher; Beerstecher, Daniel; Krüger, Tom
    Abstract: This paper examines earnings momentum strategies in the U.S. stock universe from an investor's perspective. Specifically, we use the software Stock Investor Pro from the American Association of Individual Investors (AAII) to obtain the composition of the U.S. stock universe from 2005-2015 on a weekly basis. Raw data is validated via Thomson Reuters Datastream. Next, we implement long-only and long-short earnings momentum strategies based on earnings estimates revisions. Furthermore, we develop a novel price-earnings momentum strategy by intertwining earnings momentum with a 52 week high strategy. Our findings re-confirm the high returns of the classical earnings momentum strategy with equal-weighted raw returns of 23.6 percent p.a. for the monthly long-only strategy. Most importantly, we find large parts of these raw returns to be robust to a wide spectrum of systematic sources of risk and feasible in light of market frictions, such as trading costs, liquidity constraints and microstructure effects. The enhanced price-earnings momentum strategy invests in earnings momentum stocks with below-median distance to their 52 week high. This simple alteration leads to an improvement of annualized raw returns to 31.0 percent, equally robust to systematic sources of risk and market frictions. We conclude that earnings momentum strategies are feasible and continue to pose a serious challenge to the semi-strong form of market efficiency.
    Keywords: earnings momentum,price momentum,market efficiency,return predictability
    Date: 2015
  10. By: Bams, Dennis; Pisa, Magdalena; Wolff, Christian C
    Abstract: This paper addresses issues related to industry heterogeneity, default clustering and parameter uncertainty of capital requirements in US retail loan portfolios. Using a multi-factor model of credit risk, we show that the Basel II capital requirements overstate the riskiness of small businesses. Retail exposures are a much safer investment than the regulator would suggest. We find that sensitivity to the common risk factors is low and that small business risk is predominantly a reflection of idiosyncratic risk. Our results show that only 0.00-3.39% of the asset variability is explained by economy-wide risk factors. The remaining 96.61%-100.00% of small business risk is due to changes in the firm-specific characteristics. Moreover, both expected and unexpected losses are time dependent. Their shifts over the course of financial crisis cause uncertainty in the provisions level and capital requirements. Importantly, our estimates of asset correlations are significantly lower than any available estimates for corporate firms. Our results are based on a new, representative dataset of US retail businesses from 2005 to 2011 and give fundamental insights into the US economy.
    Keywords: capital requirements
    JEL: G17 L14 L25
    Date: 2015–10

This nep-fmk issue is ©2015 by Kwang Soo Cheong. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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