nep-fmk New Economics Papers
on Financial Markets
Issue of 2016‒09‒25
nine papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Why Does Idiosyncratic Risk Increase with Market Risk? By Bartram, Sohnke M.; Brown, Gregory W.; Stulz, Rene M.
  2. Day of the Week and the Cross-Section of Returns By Birru, Justin
  3. Institutional Investments in Pure Play Stocks and Implications for Hedging Decisions By Minton, Bernadette A.; Schrand, Catherine M.
  4. Hedging Interest Rate Risk Using a Structural Model of Credit Risk By Huang, Jing-Zhi; Shi, Zhan
  5. "Whatever it takes" is all you need: monetary policy and debt fragility By Russell Cooper; Antoine Camous
  6. The Banking View of Bond Risk Premia By David Sraer; Valentin Haddad
  7. Bounds for VIX Futures given S&P 500 Smiles By Julien Guyon; Romain Menegaux; Marcel Nutz
  8. Portfolio Diversification in the Sovereign Credit Swap Markets By Consiglio, Andrea; Lotfi, Somayyeh; Zenios, Stavros A.
  9. Forecasting Financial Stress Indices in Korea: A Factor Model Approach By Hyeongwoo Kim; Wen Shi; Hyun Hak Kim

  1. By: Bartram, Sohnke M. (University of Warwick); Brown, Gregory W. (University of North Carolina); Stulz, Rene M. (Ohio State University and European Corporate Governance Institute)
    Abstract: From 1963 through 2015, idiosyncratic risk (IR) is high when market risk (MR) is high. We show that the positive relation between IR and MR is highly stable through time and is robust across exchanges, firm size, liquidity, and market-to-book groupings. Though stock liquidity affects the strength of the relation, the relation is strong for the most liquid stocks. The relation has roots in fundamentals as higher market risk predicts greater idiosyncratic earnings volatility and as firm characteristics related to the ability of firms to adjust to higher uncertainty help explain the strength of the relation. Consistent with the view that growth options provide a hedge against macroeconomic uncertainty, we find evidence that the relation is weaker for firms with more growth options.
    JEL: G10 G11 G12
    Date: 2016–07
    URL: http://d.repec.org/n?u=RePEc:ecl:ohidic:2016-13&r=fmk
  2. By: Birru, Justin (OH State University)
    Abstract: This paper documents a new empirical fact. Long-short anomaly returns are strongly related to the day of the week. Anomalies for which the speculative leg is the short (long) leg experience the highest (lowest) strategy returns on Monday. The exact opposite pattern is observed on Fridays. The effects are large; Monday (Friday) alone accounts for over 100% of monthly returns for all anomalies examined for which the short (long) leg is the speculative leg. Consistent with a mispricing explanation, the pattern is fully driven by the speculative leg of the strategy. The observed patterns are consistent with the abundance of evidence in the psychology literature documenting that mood increases from Thursday to Friday and decreases on Monday.
    JEL: A12 D84 G12 G14
    Date: 2016–01
    URL: http://d.repec.org/n?u=RePEc:ecl:ohidic:2016-1&r=fmk
  3. By: Minton, Bernadette A. (OH State University); Schrand, Catherine M. (University of PA)
    Abstract: We show that institutions invest in stocks within an industry that maintain exposure to their underlying industry risk factor. These "pure play" stocks have greater numbers of institutional investors and institutions systematically overweight them in their portfolios while underweighting low industry-exposure stocks of firms in the same nominal industry. Pure play stocks also have greater liquidity measured by stock turnover and price impact. An implication of these results is that catering to these preferences could be an important variable in firms' risk management decisions, potentially offsetting incentives to reduce volatility via hedging. We further characterize institutions' investments for pure play stocks across institution type, industries, and over time.
    JEL: G11 G23 G32
    Date: 2016–01
    URL: http://d.repec.org/n?u=RePEc:ecl:ohidic:2016-3&r=fmk
  4. By: Huang, Jing-Zhi (Pennslyvania State University); Shi, Zhan (Ohio State University)
    Abstract: Recent evidence has shown that structural models fail to capture interest rate sensitivities of corporate debt. We consider a structural model that incorporates a three-factor dynamic term structure model (DTSM) into the Merton (1974) model. We show that the proposed model largely captures the interest rate exposure of corporate bonds. We also find that for investment-grade bonds, hedging effectiveness substantially improves under the proposed model. Our results indicate that to better capture and hedge the interest rate exposure of corporate bonds, we need to incorporate a more realistic DTSM in the existing structural models.
    JEL: G12 G13 G24 G33
    Date: 2016–02
    URL: http://d.repec.org/n?u=RePEc:ecl:ohidic:2016-04&r=fmk
  5. By: Russell Cooper (Pennsylvania State University); Antoine Camous (University of Mannheim)
    Abstract: The valuation of government debt is subject to strategic uncertainty. Pessimistic lenders, fearing default, bid down the price of debt, leaving a government with a higher debt burden. This increases the likelihood of default and thus confirming the pessimism of lenders. Can monetary interventions mitigate debt fragility? With one-period commitment to a state contingent policy, the monetary authority can indeed overcome strategic uncertainty. Under discretion, debt fragility remains unless reputation effects are sufficiently strong. Simpler forms of interventions, such as an inflation target, cannot eliminate debt fragility
    Date: 2016
    URL: http://d.repec.org/n?u=RePEc:red:sed016:863&r=fmk
  6. By: David Sraer (UC Berkeley); Valentin Haddad (Princeton University)
    Abstract: Banks’ exposure to fluctuations in interest rates strongly forecasts excess Treasury bond returns. This result is consistent with a bank-centric view of the market for interest rate risk. Banks’ activities — accepting deposits and making loans — naturally exposes their balance sheets to changes in interest rates. In equilibrium, the bond risk premium compensates banks for bearing these fluctuations: for instance, when consumers demand for fixed rate mortgages increases, banks have to scale up their exposure to interest rate risk and are compensated by an increase in bond risk premium. A key insight is that the net exposure of banks, rather than quantities of particular types of loans or deposits, reveals the risk premium.
    Date: 2016
    URL: http://d.repec.org/n?u=RePEc:red:sed016:814&r=fmk
  7. By: Julien Guyon; Romain Menegaux; Marcel Nutz
    Abstract: We derive sharp bounds for the prices of VIX futures using the full information of S&P 500 smiles. To that end, we formulate the model-free sub/superreplication of the VIX by trading in the S&P 500 and its vanilla options as well as the forward-starting log-contracts. A dual problem of minimizing/maximizing certain risk-neutral expectations is introduced and shown to yield the same value. The classical bounds for VIX futures given the smiles only use a calendar spread of log-contracts on the S&P 500. We analyze for which smiles the classical bounds are sharp and how they can be improved when they are not. In particular, we introduce a family of functionally generated portfolios which often improves the classical bounds while still being tractable; more precisely, determined by a single concave/convex function on the line. Numerical experiments on market data and SABR smiles show that the classical lower bound can be improved dramatically, whereas the upper bound is often close to optimal.
    Date: 2016–09
    URL: http://d.repec.org/n?u=RePEc:arx:papers:1609.05832&r=fmk
  8. By: Consiglio, Andrea (University of Palermo); Lotfi, Somayyeh (University of Guilan); Zenios, Stavros A. (University of Cyprus and University of Pennsylvania)
    Abstract: We develop models for portfolio diversification in the sovereign credit default swap (CDS) markets and show that, despite literature findings that sovereign CDS spreads are affected by global factors, there is sufficient idiosyncratic risk to be diversified away. However, we identify regime switching in the times series of CDS spreads, and the portfolio diversification strategies may differ between regimes. The models trade of the CVaR risk measure against expected return. They are tested in an active management setting for Eurozone core, periphery, and Central, Eastern and South-Eastern Europe (CESEE) countries. Models are developed for investors with long positions in CDS, speculators that hold uncovered long and short positions, and hedgers with covered long and short exposures. The results compare favorably with the broad S&P/ISDA Eurozone Developed Nation Sovereign CDS index. We also identify several issues that remain unexplored on the way to developing integrated risk management models for CDS portfolios.
    Date: 2016–07
    URL: http://d.repec.org/n?u=RePEc:ecl:upafin:16-06&r=fmk
  9. By: Hyeongwoo Kim; Wen Shi; Hyun Hak Kim
    Abstract: We propose factor-based out-of-sample forecast models for Korea's financial stress index and its 4 sub-indices that are developed by the Bank of Korea. We extract latent common factors by employing the method of the principal components for a panel of 198 monthly frequency macroeconomic data after differencing them. We augment an autoregressive-type model of the financial stress index with estimated common factors to formulate out-of-sample forecasts of the index. Our models overall outperform both the stationary and the nonstationary benchmark models in forecasting the financial stress indices for up to 12-month forecast horizons. The first common factor that represents not only financial market but also real activity variables seems to play a dominantly important role in predicting the vulnerability in the financial markets in Korea.
    Keywords: Financial Stress Index; Principal Component Analysis; PANIC; In-Sample Fit; Out-of-Sample Forecast; Diebold-Mariano-West Statistic
    JEL: E44 E47 G01 G17
    Date: 2016–09
    URL: http://d.repec.org/n?u=RePEc:abn:wpaper:auwp2016-10&r=fmk

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