nep-fmk New Economics Papers
on Financial Markets
Issue of 2016‒08‒21
six papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. An Experimental Study of Bond Market Pricing By Matthias Weber; John Duffy; Arthur Schram
  2. Contingent convertible bonds with floating coupon payments: fixing the equilibrium problem By Daniël Vullings
  3. Ambiguity and Time-Varying Risk Aversion in Sovereign Debt Markets By Christoph Große Steffen; Maximilian Podstawski
  4. A macrofinance view of US Sovereign CDS premiums By Lukas Schmid; Andres Schneider; Mikhail Chernov
  5. Are Euro-Area Corporate Bond Markets Irrelevant? The Effect of Bond Market Access on Investment By von Beschwitz, Bastian; Howells, Conor T.
  6. Determinants of Launch Spreads on EM USD-Denominated Corporate Bonds By Naoto Higashio; Takahiro Hirakawa; Ryo Nagaushi; Shinsuke Ohyama; Atsushi Takanashi

  1. By: Matthias Weber (Bank of Lithuania, and Vilnius University, Lithuania); John Duffy (University of California, Irvine, United States); Arthur Schram (VU University Amsterdam, the Netherlands)
    Abstract: An important feature of bond markets is the relationship between initial public offering prices and the probability of the issuer defaulting. First, this probability affects the bond prices. Second, IPO prices determine the default probability. Though market equilibrium has been shown to predict well for other assets, it is a priori unclear whether markets will yield competitive prices when such interaction with the default probability occurs. We develop a flexible bond market model that is easily implemented in the laboratory and examine how subjects price bonds. We find that subjects learn to price bonds well after only a few repetitions.
    Keywords: bond markets; experimental finance; experimental markets; asset pricing; learning
    JEL: C92 C90 D47 G12
    Date: 2016–08–09
  2. By: Daniël Vullings
    Abstract: Contingent convertible bonds (CoCos) are increasingly popular financial instruments used by banks to satisfy capital requirements. CoCos with market-based conversion triggers in particular receive much attention in the literature. The pricing of CoCos with such a market trigger is problematic as the market value of equity itself depends on the firm's capital structure. This results in a not-unique arbitrage-free price for the CoCos. We propose a new type of CoCos with a market based trigger and floating coupons. The coupons increase near the trigger value to compensate CoCo holders for the possibility of bankruptcy before conversion. This leads to a unique no-arbitrage price before conversion. The properties of the innovative CoCo contract are studied for different dynamic models of a bank's assets, such as the (Black-Scholes) Merton and stochastic volatility jump diffusion model. In particular, we illustrate how the CoCo coupons vary as functions of jump intensities and volatilities.
    Keywords: Contingent Convertible bonds; market trigger; floating coupons
    JEL: G13 G21 G28
    Date: 2016–08
  3. By: Christoph Große Steffen; Maximilian Podstawski
    Abstract: This paper introduces changes in the level of ambiguity as a complementary source of time-varying risk aversion. We show in a consumption-based asset pricing model with simultaneously risky and ambiguous assets that a rise in the level of ambiguity raises investors' risk aversion. The effect is quantified in an application to European sovereign debt markets using a structural VAR to achieve identification in the data. We proxy for ambiguity using a measure of macroeconomic uncertainty and decompose empirically credit default swaps (CDS) for Spain and Italy into three shocks: fundamental default risk, risk aversion, and uncertainty. We find that shocks to uncertainty significantly increase international investors' risk aversion, accounting for about one fifth of its variation at a five week horizon, and have a significant and economically relevant impact on sovereign financing premia
    Keywords: Time-varying risk aversion, Ambiguity, Uncertainty, Sovereign debt, Identification via heteroscedasticity, Maxmin
    JEL: C32 D80 E43 G01 H63
    Date: 2016
  4. By: Lukas Schmid (Duke University); Andres Schneider (UCLA); Mikhail Chernov (UCLA)
    Abstract: Premiums on US sovereign CDS have risen to persistently elevated levels since the financial crisis. In this paper, we ask whether these premiums reflect the probability of a US \emph{fiscal default}, namely a state in which budget balance can no longer be restored by further raising taxes or eroding the real value of debt by raising inflation. To that end, we develop a tractable equilibrium macrofinance model of the US economy, in which the fiscal and monetary policy stance jointly endogenously determine nominal debt, taxes, inflation and growth. While US CDS cannot be valued using standard replication arguments, we show how in our equilibrium model, CDS premiums reflect endogenous risk adjusted fiscal default probabilities. A calibrated version of the model is quantitatively consistent with high premiums on US sovereign CDS.
    Date: 2016
  5. By: von Beschwitz, Bastian; Howells, Conor T.
    Abstract: We compare how bond market access affects firms’ investment decisions in the United States and the euro area. Having a bond rating enables US corporations to invest more and undertake more acquisitions. In contrast, in the euro area, bond ratings have no effect on investment decisions. Similarly, firms with bond ratings have higher leverage in the United States, but not in the euro area. This difference may be due to euro-area firms getting sufficient financing from banks. Consistent with this explanation, euro-area bond ratings became more relevant for investment after the banking crisis of 2008, when banks reduced their lending to firms.
    Keywords: Mergers and acquisitions ; Bond ratings ; Investment ; Financing constraints
    JEL: G31 G32 G34
    Date: 2016–06–30
  6. By: Naoto Higashio (Bank of Japan); Takahiro Hirakawa (Bank of Japan); Ryo Nagaushi (Bank of Japan); Shinsuke Ohyama (Bank of Japan); Atsushi Takanashi (Bank of Japan)
    Abstract: This paper examines the development of launch (primary) spreads (the difference between a bond's yield to maturity at issuance and U.S. Treasury yields of corresponding maturity) on USD-denominated corporate bonds issued by emerging market (hereafter "EM") companies since the mid-1990s and decomposes their determinants to assess the primary market environment surrounding EM companies. Our empirical results indicate that while the launch spreads on EM corporate bonds properly reflect firm-specific factors as structural credit models suggest, they are also affected by those market-wide factors that describe the primary market environment at issuance (hereafter "time effects"). During the 2004 to 2008 and 2010 to 2015 periods, the time effects clearly lowered the launch spreads to a level well below the long-term average prior to the global financial crisis of 2008, which indicates that the primary market environment for EM USD-denominated corporate bonds was favorable by historical standards during these periods. In addition, we find that the more accommodative the Fed's monetary policy is, and the more stable U.S. financial markets are, the lower the launch spreads on EM USD-denominated corporate bonds are. This finding is in line with the view that the accommodative and stable financial conditions in the U.S. contributed to improving USD funding conditions for EM companies since 2010.
    Date: 2016–08–10

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