nep-fmk New Economics Papers
on Financial Markets
Issue of 2017‒11‒05
five papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Costly Interpretation of Asset Prices By Vives, Xavier; Yang, Liyan
  2. A Dynamic Measure of Intentional Herd Behavior in Financial Markets By Park, Beum-Jo; Kim, Myung-Joong
  3. A quantitative analysis of risk premia in the corporate bond market By Sara Cecchetti
  4. Thinking about the Asian Infrastructure Investment Bank: Can a China-Led Development Bank Improve Sustainability in Asia? By Robert J. Hanlon
  5. Stock Market Reactions to India's 2016 Demonetization: Implications for Tax Evasion, Corruption, and Financial Constraints By Dhammika Dharmapala; Vikramaditya Khanna

  1. By: Vives, Xavier; Yang, Liyan
    Abstract: We propose a model in which investors cannot costlessly process information from asset prices. At the trading stage, investors are boundedly rational and their interpretation of prices injects noise into the price, generating a source of endogenous noise trading. Compared to the standard rational expectations equilibrium, our setup features price momentum and yields higher return volatility and excessive trading volume. In an overall equilibrium, investors optimally choose sophistication levels by balancing the benefit of beating the market against the cost of acquiring sophistication. Investors tend to over-acquire sophistication. There can exist strategic complementarity in sophistication acquisition, leading to multiple equilibria.
    Keywords: asset prices; disagreement; Investor sophistication; multiplicity; noise trading; trading volume; welfare
    Date: 2017–10
  2. By: Park, Beum-Jo; Kim, Myung-Joong
    Abstract: This paper suggests a dynamic measure of intentional herding, causing the excess volatility or even systemic risk in financial markets, which is based on a new concept of cumulative returns in the same direction as well as the collective behavior of all investors towards the market consensus. Differing from existing measures, the measure allows us to directly detect time-varying and market-wide intentional herding using the model of Dynamic Conditional Correlation (DCC) (Engle, 2002) between the financial market and its components that is partially free of spurious herding due to the inclusion of the variables of the number of economic news announcements as a proxy of market information. Strong evidence in favor of the dynamic measure over the other measures is based on empirical application in the U.S. markets (DJIA and S&P100), supporting the tendency to exhibit time-varying intentional herding. Much more important is a finding that the impact of intentional herding on market volatility tends to be stronger during the periods of turbulent markets like the degradation of U.S. sovereign credit rating by S&P, and be more significant in S&P 100 than DJIA.
    Keywords: Intentional herd behavior, Dynamic conditional correlation, News announcements, Dynamic measure, Herding tests, Volatility, Quantile regression
    JEL: C10 G0 G02
    Date: 2017–10–01
  3. By: Sara Cecchetti (Bank of Italy)
    Abstract: We propose an econometric model to decompose corporate bond spreads into compensation required by investors for unpredictable future changes in the credit environment and for expected default losses. We use the model to understand whether the significant reduction in corporate bond spreads observed since the launch of the CSPP (Corporate Sector Purchase Programme) is attributable more to the fact that expansionary monetary policy measures tend to increase the risk appetite of investors and compress risk premia, or to the ability of unconventional measures to reduce expected default losses by improving investors’ expectations about the economic and financial conditions of issuers.
    Keywords: bond excess return, credit default swap, distress risk premium, expected default frequancy, jump-at-default risk premium
    JEL: B26 C02 F30 G12 G15
    Date: 2017–10
  4. By: Robert J. Hanlon
    Abstract: This article offers three arguments outlining the Asian Infrastructure Investment Bank's significance and to help policy planners navigate the complex relationship between China, the Bank and themes of sustainability. First, there is little uncertainty that China is serious about development and sustainability. The Asian Infrastructure Investment Bank is but one extension of China's increasing commitment to sustainability and should therefore be embraced by development stakeholders. Second, the Asian Infrastructure Investment Bank's commitment to infrastructure development complements other multilateral development banks and should not be considered a challenger to the existing order of development lending practices. Rather, China's interest in establishing the Asian Infrastructure Investment Bank points to competitive pluralism and poses no threat to the existing international order. Finally, the Asian Infrastructure Investment Bank's sustainability guidelines are not unique and fall in line with similar policy of other large development banks. The Asian Infrastructure Investment Bank therefore reinforces sustainability norms while posturing itself as a partner for development.
    Keywords: AIIB, China, multilateral development banks, sustainability, construction
    Date: 2017–07–11
  5. By: Dhammika Dharmapala; Vikramaditya Khanna
    Abstract: On November 8, 2016, the Indian government made a surprise announcement that certain currency notes (representing 86% of the currency then in circulation) would no longer be legal tender (although they could be deposited in banks over a limited period). The stated reason for this sudden “demonetization” was to combat tax evasion and corruption associated with “unaccounted-for” cash. We compute abnormal returns for firms on the Indian stock market around this event, and compare patterns of abnormal returns for different subsamples of firms defined by industry, ownership structure, and other characteristics. There is little evidence that sectors thought to be associated with greater tax evasion or corruption experienced significantly different returns. However, we find substantial positive returns for banks and for state owned enterprises (SOEs), implying market expectations that are puzzling in some respects, especially as the initial reactions do not show any evidence of reversal in the five months following the event. The bank results appear to indicate a market expectation of a persistent increase in financial depth. We also find a pattern of higher returns for industries that are characterized by a greater dependence on external finance, possibly suggesting an expectation of an easing of financial constraints. The returns for SOEs may be due to possible indirect effects of the announcement on perceptions of future corruption among these firms.
    Keywords: corruption, tax evasion, demonetization, financial constraints, India
    JEL: E42 H26
    Date: 2017

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