nep-fmk New Economics Papers
on Financial Markets
Issue of 2015‒12‒28
nine papers chosen by

  1. Industry based equity premium forecasts By Nuno Silva
  2. Predictive Models for Disaggregate Stock Market Volatility By Chong, Terence Tai Leung; Lin, Shiyu
  3. Asymptotic pricing in large financial markets By Micha{\l} Barski
  4. Which Alpha? By Francisco Barillas; Jay Shanken
  5. Anticipatory Effects in the FTSE 100 Index Revisions By Marcelo Fernandes; João Mergulhão
  6. A global factor in variance risk premia and local bond pricing By Kaminska, Iryna; Roberts-Sklar, Matt
  7. Forward Guidance in the Yield Curve: Short Rates versus Bond Supply By Robin Greenwood; Samuel Hanson; Dimitri Vayanos
  8. "Completing the Single Financial Market and New Fiscal Rules for the Euro Area" By Mario Tonveronachi
  9. How much diversification potential is there in a single market? Evidence from the Australian Stock Exchange By Libin Yang; William Rea; Alethea Rea

  1. By: Nuno Silva (University of Coimbra/GEMF)
    Abstract: In this paper we used industry indexes to predict the equity premium in the US. We considered several types of predictive models: i) constant coefficients and constant volatility, ii) drifting coefficients and constant volatility, iii) constant coefficients and stochastic volatility and iv) drifting coefficients and stochastic volatility. The models were estimated through the particle learning algorithm, which is suitable for dealing with the problem that an investor faces in practice, given that it allows the investor to revise the parameters as new information arrives. All the models exhibit similar statistical predictive ability, but stochastic volatility models generate slightly higher utility gains.
    Keywords: equity premium prediction, industries, particle filter, combination of forecasts.
    JEL: C11 G11 G14 G17
    Date: 2015–12
  2. By: Chong, Terence Tai Leung; Lin, Shiyu
    Abstract: This paper incorporates the macroeconomic determinants into the forecasting model of industry-level stock return volatility in order to detect whether different macroeconomic factors can forecast the volatility of various industries. To explain different fluctuation characteristics among industries, we identified a set of macroeconomic determinants to examine their effects. The Clark and West (2007) test is employed to verify whether the new forecasting models, which vary among industries based on the in-sample results, can have better predictions than the two benchmark models. Our results show that default return and default yield have significant impacts on stock return volatility.
    Keywords: Industry level stock return volatility; Out-of-sample forecast; Granger Causality.
    JEL: C12 G12
    Date: 2015–11–08
  3. By: Micha{\l} Barski
    Abstract: The problem of hedging and pricing sequences of contingent claims in large financial markets is studied. Connection between asymptotic arbitrage and behavior of the $\alpha$~-~quantile price is shown. The large Black-Scholes model is carefully examined.
    Date: 2015–12
  4. By: Francisco Barillas; Jay Shanken
    Abstract: A common approach to comparing asset pricing models with traded factors involves a competition between models in pricing test-asset returns. We find that such practice, while seemingly reasonable, cannot be relied on to determine which is the superior model for several widely accepted criteria including statistical likelihood, Sharpe ratios and a modified HJ distance. All that matters for model comparison is the extent to which each model is able to price the factors in the other model. Given this information, test assets are actually irrelevant, whether the models are nested or non-nested.
    JEL: G11 G12
    Date: 2015–11
  5. By: Marcelo Fernandes (Queen Mary University of London and Sao Paulo School of Economics, FGV); João Mergulhão (Sao Paulo School of Economics, FGV)
    Abstract: This paper examines the price impact of trading due to expected changes in the FTSE 100 index composition, which employs publicly-known objective criteria to determine membership. Hence, it provides a natural context to investigate anticipatory trading effects. We propose a panel-regression event study that backs out these anticipatory effects by looking at the price impact of the ex-ante probability of changing index membership status. Our findings reveal that anticipative trading explains about 40% and 23% of the cumulative abnormal returns of additions and deletions, respectively. The results are both statistically and economically significant.
    Keywords: Imperfect substitutes, Index revision, Liquidity, Price pressure
    JEL: G12 G15 C14
    Date: 2015–12
  6. By: Kaminska, Iryna (Bank of England); Roberts-Sklar, Matt (Bank of England)
    Abstract: In a world of interconnected financial markets it is plausible that risk appetite — an important factor in asset pricing — is determined globally. By constructing an estimate of variance risk premia (VRP) for UK, US and euro-area equity markets, we are able to estimate international variance risk premia and use them to construct a proxy for global risk aversion. The impact of this time-varying risk aversion proxy on bond risk premia is then analysed within an arbitrage-free term structure model of UK interest rates, where it is introduced explicitly as a pricing factor. By linking VRP to a stochastic discount factor, we find that the risk aversion factor has significantly affected UK government bond yields. The changes in the risk aversion factor have been particularly important in the period of the 2008–09 financial crisis, with medium maturity yields being affected the most.
    Keywords: Affine term structure models; option implied volatility; realized volatility; risk aversion; stochastic discount factor; variance risk premium; volatility forecasting
    JEL: C22 C52 E43 G12
    Date: 2015–12–21
  7. By: Robin Greenwood; Samuel Hanson; Dimitri Vayanos
    Abstract: We present a model of the yield curve in which the central bank can provide market participants with forward guidance on both future short rates and on future Quantitative Easing (QE) operations, which affect bond supply. Forward guidance on short rates works through the expectations hypothesis, while forward guidance on QE works through expected future bond risk premia. If a QE operation is expected to be undone in the near term, then its announcement will have a hump-shaped effect on the yield and forward-rate curves; otherwise the effect may be increasing with maturity. Humps associated to QE announcements typically occur at maturities longer than those associated to short-rate announcements, even when the effects of the former are expected to last over a shorter horizon. We use our model to re-examine the empirical evidence on QE announcements in the US.
    JEL: G12 G18
    Date: 2015–12
  8. By: Mario Tonveronachi
    Abstract: Until market participants across the euro area face a single risk-free yield curve rather than a diverse collection of quasi-risk-free sovereign rates, financial market integration will not be complete. Unfortunately, the institution that would normally provide the requisite benchmark asset--a federal treasury issuing risk-free debt--does not exist in the euro area, and there are daunting political obstacles to creating such an institution. There is, however, another way forward. The financial instrument that could provide the foundation for a single market already exists on the balance sheet of the European Central Bank (ECB): legally, the ECB could issue "debt certificates" (DCs) across the maturity spectrum and in sufficient amounts to create a yield curve. Moreover, reforming ECB operations along these lines may hold the key to addressing another of the euro area's critical dysfunctions. Under current conditions, the Maastricht Treaty's fiscal rules create a vicious cycle by contributing to a deflationary economic environment, which slows the process of debt adjustment, requiring further deflationary budget tightening. By changing national debt dynamics and thereby enabling a revision of the fiscal rules, the DC proposal could short-circuit this cycle of futility.
    Date: 2015–12
  9. By: Libin Yang; William Rea; Alethea Rea
    Abstract: We present four methods of assessing the diversification potential within a stock market, two of these are based on principal component analysis. They were applied to the Australian stock exchange for the years 2000 to 2014 and all show a consistent picture. The potential for diversification declined almost monotonically in the three years prior to the 2008 financial crisis. On one of the measures the diversification potential declined even further in the 2011 European debt crisis and the American credit downgrade.
    Date: 2015–12

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