nep-fmk New Economics Papers
on Financial Markets
Issue of 2017‒04‒23
four papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Testing for Alpha in Linear Factor Pricing Models with a Large Number of Securities By M. Hashem Pesaran; Takashi Yamagata
  2. The inflation risk premium in the post-Lehman period By Camba-Méndez, Gonzalo; Werner, Thomas
  3. Stress Testing in Wartime and in Peacetime By Schuermann, Til
  4. Price Jumps in Developed Stock Markets: The Role of Monetary Policy Committee Meetings By Rangan Gupta; Chi Keng Marco Lau; Ruipeng Liu; Hardik A. Marfatia

  1. By: M. Hashem Pesaran; Takashi Yamagata
    Abstract: This paper proposes a novel test of zero pricing errors for the linear factor pricing model when the number of securities, N, can be large relative to the time dimension, T, of the return series. The test is based on Student t tests of individual securities and has a number of advantages over the existing standardised Wald type tests. It allows for non-Gaussianity and general forms of weakly cross correlated errors. It does not require estimation of an invertible error covariance matrix, it is much faster to implement, and is valid even if N is much larger than T. Monte Carlo evidence shows that the proposed test performs remarkably well even when T = 60 and N = 5,000. The test is applied to monthly returns on securities in the S&P 500 at the end of each month in real time, using rolling windows of size 60. Statistically significant evidence against Sharpe-Lintner CAPM and Fama-French three factor models are found mainly during the recent financial crisis. Also we find a significant negative correlation between a twelve-months moving average p-values of the test and excess returns of long/short equity strategies (relative to the return on S&P 500) over the period November 1994 to June 2015, suggesting that abnormal profits are earned during episodes of market inefficiencies.
    Keywords: CAPM, Testing for alpha, Weak and spatial error cross-sectional dependence, S&P 500 securities, Long/short equity strategy.
    JEL: C12 C15 C23 G11 G12
    Date: 2017–04
  2. By: Camba-Méndez, Gonzalo; Werner, Thomas
    Abstract: In this paper we construct model-free and model-based indicators for the inflation risk premium in the US and the euro area. We study the impact of market liquidity, surprises from inflation data releases, inflation volatility and deflation fears on the inflation risk premium. For our analysis, we construct a special dataset with a broad range of indicators. The dataset is carefully constructed to ensure that at every point in time the series are aligned with the information set available to traders. Furthermore, we adopt a Bayesian variable selection procedure to deal with the strong multicollinearity in the variables that potentially can explain the movements in the inflation risk premium. We find that the inflation risk premium turned negative, on both sides of the Atlantic, during the post-Lehman period. This confirms the recent finding by Campbell et al. (2016) that nominal bonds are no longer "inflation bet" but have turned into "deflation hedges". We also find, and contrary to common beliefs, that indicators of inflation uncertainty alone cannot explain the movements in the inflation risk premium in the post-Lehman period. The decline in the inflation risk premium seems mostly related to increased deflation fears and the belief that inflation will stay far away from the monetary policy target rather than declining inflation uncertainty. This in turn would suggest that central banks should not be complacent with low or even negative inflation risk premia. JEL Classification: E44, G17
    Keywords: inflation expectations, Inflation linked swaps, inflation risk premium
    Date: 2017–03
  3. By: Schuermann, Til (Oliver Wyman)
    Abstract: Stress testing served us well as a crisis management tool, and we see it applied increasingly to peacetime oversight of banks and banking systems. It is rapidly becoming the dominant supervisory tool on both sides of the Atlantic. Yet the objectives and certainly the conditions are quite different, and to date we see a range of practices across jurisdictions. Stress testing has proved to be enormously useful, not just for the supervisors but also for the banks. Using a simple taxonomy of stress testing-–scenario design, models and projections, and disclosure--I analyze some of those different approaches with a view to examining how wartime stress testing can be adapted to peacetime concerns.
    JEL: G21 G28 G32
    Date: 2016–03
  4. By: Rangan Gupta (Department of Economics, University of Pretoria, Pretoria, South Africa); Chi Keng Marco Lau (Newcastle Business School, Northumbria University, Newcastle, UK); Ruipeng Liu (Department of Finance, Deakin Business School, Deakin University, Melbourne, Australia); Hardik A. Marfatia (Department of Economics, Northeastern Illinois University, Chicago, USA)
    Abstract: In this paper, we analyze the degree of occasional large price changes and extreme volatility – known as jump intensity – in the Euro area, Japan, the UK and the US. We also measure the reaction of jump intensity in these markets to the US Federal Reserve meetings as well as of the country’s own monetary policy meetings. The results indicate that the conditional jump intensity in all the markets follows a highly persistent process. Evidence suggests that the US monetary policy positively impacts the jump intensity in the case of the UK, Euro, and the US, including in the sub-sample periods found by the structural break test. Moreover, in assessing the joint effects, we find that the US continues to maintain the central role in driving the jump intensities, with it having even a greater role than monetary policy of the country itself.
    Keywords: Jump intensity, Developed stock markets, Monetary policy committee meeting dates
    JEL: C22 G15
    Date: 2017–04

This nep-fmk issue is ©2017 by Kwang Soo Cheong. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.