nep-fmk New Economics Papers
on Financial Markets
Issue of 2015‒12‒01
three papers chosen by

  1. Upside and Downside Risks in Momentum Returns By Victoria Dobrynskaya
  2. Speculators, Prices and Market Volatility By Celso Brunetti; Bahattin Buyuksahin; Jeffrey H. Harris
  3. Towards a General Theory of the Stock Market By John Fender

  1. By: Victoria Dobrynskaya (National Research University Higher School)
    Abstract: I provide a novel risk-based explanation for the profitability of momentum strategies. I show that the past winners and the past losers are differently exposed to the upside and downside market risks. Winners systematically have higher relative downside market betas and lower relative upside market betas than losers. As a result, the winner-minus-loser momentum portfolios are exposed to extra downside market risk, but hedge against the upside market risk. Such asymmetry in the upside and downside risks is a mechanical consequence of rebalancing momentum portfolios. But it is unattractive for an investor because both positive relative downside betas and negative relative upside betas carry positive risk premiums according to the Downside-Risk CAPM. Hence, the high returns to momentum strategies are a mere compensation for their upside and downside risks. The Downside Risk-CAPM is a robust unifying explanation of returns to momentum portfolios, constructed for different geographical and asset markets, and it outperforms alternative multi-factor models.
    Keywords: momentum, downside risk, downside beta, upside risk, upside beta, Downside-Risk CAPM
    JEL: G12 G14 G15
    Date: 2015
  2. By: Celso Brunetti; Bahattin Buyuksahin; Jeffrey H. Harris
    Abstract: We analyze data from 2005 through 2009 that uniquely identify categories of traders to assess how speculators such as hedge funds and swap dealers relate to volatility and price changes. Examining various subperiods where price trends are strong, we find little evidence that speculators destabilize financial markets. To the contrary, hedge funds facilitate price discovery by trading with contemporaneous returns while serving to reduce volatility. Swap dealer activity, however, is largely unrelated to both contemporaneous returns and volatility. Our evidence is consistent with the hypothesis that hedge funds provide valuable liquidity and largely serve to stabilize futures markets.
    Keywords: International topics, Recent economic and financial developments
    JEL: C3 G1
    Date: 2015
  3. By: John Fender
    Abstract: Although there are many stock markets anomalies which the Efficient Market Hypothesis (EMH) finds difficult to explain, it also has its strengths, and so far no alternative hypothesis has been developed which can explain what the EMH explains but which can also do a better job in explaining the phenomena with which it struggles. It is argued that the way forward is to postulate that the stock market can be in one of three states: a fundamental state, in which share prices are determined as in the EMH, a bubble or bull market state, in which share prices are above their fundamental levels but continue to rise because asset holders expect to sell the shares at even higher prices in the future, and a bear market state, in which shares are held exclusively by 'irrational' agents and rational agents cannot exploit the overvaluation because of short-selling constraints. It is also argued that heterogeneous rational expectations may help explain some features of stock market behaviour.
    Keywords: efficient market hypothesis, rational expectations, bubbles, bear markets, short-selling constraints
    JEL: G1
    Date: 2015–10

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