nep-fmk New Economics Papers
on Financial Markets
Issue of 2017‒01‒29
seven papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Fake Alpha By Marcel Müller; Tobias Rosenberger; Marliese Uhrig-Homburg;
  2. Expected Currency Returns and Volatility Risk Premia By José Renato Haas Ornelas
  3. Costs of capital under credit risk By Peter Reichling; Anastasiia Zbandut
  4. A Multi-Criteria Portfolio Analysis of Hedge Fund Strategies By David E. Allen; Michael McAleer; Abhay K. Singh
  5. Uncovering Skilled Short-sellers By Fernando Chague; Rodrigo De Losso, Bruno Giovannetti
  6. Contagion in the CDS Market By H Peyton Young; Mark Paddrik
  7. Is there a Long-Term Relationship among European Sovereign Bond Yields? By Ian Schaeffer; Miguel D. Ramirez

  1. By: Marcel Müller; Tobias Rosenberger; Marliese Uhrig-Homburg;
    Abstract: Why do investors entrust active mutual fund managers with large sums of money while receiving negative excess returns on average? Our explanation is that investors have a coarser information set than fund managers which leads them to systematically misinterpret managers' skill. When investors are unable to correctly quantify risk because they have no knowledge of factor investing on beyond-market-risk factors, Fake Alpha strategies based on factor investing look like skill from the investors' perspective. As running such strategies is relatively cheap for the managers, the investors' coarser information set misleads them to invest beyond the point of zero excess returns in equilibrium. We confirm our theory by analyzing the sample of US equity active managed mutual funds and find significant evidence of decreasing returns to scale at the fund level as well as negative excess returns to investors in equilibrium states.
    Keywords: mutual funds, active management, managerial skill, alpha
    JEL: G23 G11 G20
    Date: 2017–01
  2. By: José Renato Haas Ornelas
    Abstract: This paper addresses the predictive ability of currency volatility risk premium - the difference between an implied and a realized volatility - over US dollar exchange rates using a time-series perspective. The intuition is that, when risk aversion sentiment increases, the market quickly discounts the currency, and later this discount is “accrued”, leading to a future currency appreciation. Based on two different samples with a diversified set of 32 currencies, I document a positive relationship between currency volatility risk premium and future currency returns. Results remain robust even after controlling for traditional fundamental predictors like Purchase Power Parity and interest rate differential
    Date: 2017–01
  3. By: Peter Reichling (Faculty of Economics and Management, Otto-von-Guericke University Magdeburg); Anastasiia Zbandut (Faculty of Economics and Management, Otto-von-Guericke University Magdeburg)
    Abstract: Credit risk analysis represents a growing field in financial research since decades. However, in company valuation – to be more precise, in cost of capital computations – credit risk is merely taken into consideration at the level of the debt beta approach. Our paper proves that applications of the debt beta approach suffer from unrealistic assumptions. As an advantageous approach, we develop an alternative framework to determine costs of capital based on Merton’s model. We present (quasi-) analytic formulas for costs of equity and debt which are consistent with Modigliani-Miller theory in continuous-time and discrete-time settings without taxes. Our framework is superior to the debt beta approach regarding the quantity and quality of required data in peer group analysis. Since equity and debt are represented by options in Merton’s model, we compute expected option rates of return without resorting to betas. Thereby, our paper also contributes to the option pricing literature.
    Keywords: Company valuation, debt beta, expected option return, Merton’s model, WACC
    JEL: G13 G32 G33
    Date: 2017–01
  4. By: David E. Allen (Centre for Applied Financial Studies, University of South Australia, School of Mathematics and Statistics,); Michael McAleer (Department of Quantitative Finance, College of Technology Management, National Tsing Hua University,); Abhay K. Singh (School of Business and Law, Edith Cowan University)
    Abstract: This paper features a tri-criteria analysis of Eurekahedge fund data strategy index data. We use nine Eurekahedge equally weighted main strategy indices for the portfolio analysis. The tri-criteria analysis features three objectives: return, risk and dispersion of risk objectives in a Multi-Criteria Optimisation (MCO) portfolio analysis. We vary the MCO return and risk targets and contrast the results with four more standard portfolio optimisation criteria, namely the tangency portfolio(MSR), the most diversied portfolio (MDP), the global minimum variance portfolio (GMW), and portfolios based on minimising expected shortfall (ERC). Backtests of the chosen portfolios for this hedge fund data set indicate that the use of MCO is accompanied by uncertainty about the a priori choice of optimal parameter settings for the decision criteria. The empirical results do not appear to outperform more standard bi-criteria portfolio analyses in the backtests undertaken on our hedge fund index data.
    Keywords: MCO; Portfolio Analysis; Hedge Fund Strategies; Multi-Criteria Optimisation,
    JEL: G15 G17 G32 C58 D53
    Date: 2017–01–23
  5. By: Fernando Chague; Rodrigo De Losso, Bruno Giovannetti
    Abstract: Using a deal-level data set we classify all Brazilian short-sellers according to their performance and trading behavior. Our goal is to uncover the “skilled short-sellers.” We analyze their deals in isolation to study their superior trading performance. Skilled short-sellers earn on average 1.67% more per deal than unskilled short-sellers, with 73% of this superior performance coming from stock-picking skill and the remaining 27% coming from market-timing skill. Skilled short-sellers are also proficient at choosing when to cover their positions. Unlike unskilled short-sellers, skilled short-sellers behave as short-term momentum investors and display no disposition effect.
    Keywords: short-selling; skill; stock-picking; market-timing; disposition effect
    JEL: G12 G14
    Date: 2017–01–11
  6. By: H Peyton Young; Mark Paddrik
    Abstract: Abstract This paper analyzes counterparty exposures in the credit default swaps market and examines the impact of severe credit shocks on the demand for variation margin, which are the payments that counterparties make to offset price changes. We employ the Federal Reserve's Comprehensive Capital Analysis and Review (CCAR) shocks and estimate their impact on the value of CDS contracts and the variation margin owed. Large and sudden demands for variation margin may exceed a firm's ability to pay, leading some firms to delay or forego payments. These shortfalls can become amplified through the network of exposures. Of particular importance in cleared markets is the potential impact on the central counterparty clearing house. Although a central node according to conventional measures of network centrality, the CCP contributes less to contagion than do several peripheral firms that are large net sellers of CDS protection. During a credit shock these firms can suffer large shortfalls that lead to further shortfalls for their counterparties, amplifying the initial shock.
    Keywords: Credit default swaps, stress testing, systemic risk, financial networks
    JEL: D85 G01 G17 L14
    Date: 2017–01–24
  7. By: Ian Schaeffer; Miguel D. Ramirez (Department of Economics, Trinity College)
    Abstract: The integration of financial markets has been a recurring theme in academic and financial research. The majority of the literature has focused on equity markets. Literature on the integration of international bond markets is not as common, specifically regarding that of European bonds since the beginning of the common currency area in 1999. This paper estimates a fixed effects pooled model and then proceeds to undertake panel unit root and cointegration tests to determine the degree of co-movement of European sovereign bond yields. The reported estimates suggest that yields move together over time, thus the benefits of diversification in European government bond portfolios may be limited. The results also have important implications for monetary policy. Given that economic shocks (e.g. inflationary shocks) are transmitted quickly from country to country, then it will complicate the task of monetary policy when it comes to pursuing an independent policy with respect to domestic monetary conditions in the presence of asymmetric economic shocks.
    Keywords: European Monetary Union; Fully modified ordinary least squares (FMOLS); Pairwise Granger Causality tests; Panel unit roots; Panel cointegration; Sovereign bond yields.
    JEL: C23 N23 O52
    Date: 2017–01

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