nep-fmk New Economics Papers
on Financial Markets
Issue of 2018‒01‒01
three papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Do Firm Fixed Effects Matter in Empirical Asset Pricing? By Hoechle, Daniel; Schmid, Markus; Zimmermann, Heinz
  2. Modelling stock price-exchange rate nexus in OECD countries - A new perspective By Afees A. Salisu; Umar B. Ndako
  3. Cross-Sectional and Time-Series Momentum Returns and Market Dynamics: Are Islamic Stocks Different? By Muhammad A. Cheema; Gilbert V. Nartea

  1. By: Hoechle, Daniel; Schmid, Markus; Zimmermann, Heinz
    Abstract: In empirical asset pricing, it is standard to sort assets into portfolios based on a characteristic, and then compare the top (e.g., decile) portfolio's risk-adjusted return with that of the bottom portfolio. We show that such an analysis assumes the random effects assumption to hold. Therefore, results from portfolio sorts are valid if and only if firm-specific effects are uncorrelated with the characteristic underlying the portfolio sort. We propose a novel, regression-based approach to analyzing asset returns. Relying on standard econometrics, our technique handles multiple dimensions and continuous firm characteristics. Moreover, it nests all variants of sorting assets into portfolios as a special case, provides a means for testing the random effects assumption, and allows for the inclusion of firm-fixed effects in the analysis. Our empirical results demonstrate that the random effects assumption underlying portfolio sorts is often violated, and that certain characteristics-based factors that are wellknown from empirical asset pricing studies do not withstand tests accounting for firm fixed effects.
    Keywords: Portfolio sorts, Random effects assumption, Cross-section of expected returns, Fama-French three-factor model
    JEL: C21 G14 D1
    Date: 2017–11
  2. By: Afees A. Salisu (Centre for Econometric and Allied Research, University of Ibadan); Umar B. Ndako (Monetary Policy Department, Central Bank of Nigeria, Nigeria.)
    Abstract: This paper subjects the Portfolio Balance Theory to empirical scrutiny using panel data of OECD countries. Thus, it examines the response of exchange rate to stock price changes contrary to the prominent practice in the literature where the former is hypothesized as the predictor. It also tests for the role of asymmetries in the nexus in response to the increasing evidence in the literature suggesting that most financial series tend to exhibit leverage effects. Given the significance of Euro currency in the OECD, we further partition the full data into Euro and Non-Euro areas. In addition, separate regressions are conducted for the pre- and post-Global Financial Crises (GFC) in order to account for the role of financial crisis in the nexus. For robustness, we consider both nominal and real variables and multiple data frequencies. In all, our findings validate the Portfolio Balance Theory for the full OECD, the Euro area, and the non-Euro area, albeit with lesser evidence for the latter. Also, the validity of the theory became more evident after the global financial crises while both long-run and short-run asymmetries are present in the nexus regardless of the data sample. Interestingly, our findings that give rise to this conclusion are robust to different data frequencies and variable measurements.
    Keywords: OECD; stock price; exchange rate; portfolio balance theory; asymmetry; global financial crisis
    JEL: C53 F31 G11
    Date: 2017–12
  3. By: Muhammad A. Cheema; Gilbert V. Nartea (University of Canterbury)
    Abstract: We search for differences in both unconditional and conditional momentum returns of Islamic and Non-Islamic stocks and test implications of competing behavioral theories that aim to explain momentum returns. Our results show that there is no significant difference in momentum returns between Islamic versus Non-Islamic stocks with respect to both cross-sectional (CS) and time-series (TS) momentum strategies even when we condition momentum returns on market dynamics, information uncertainty (IU), and idiosyncratic volatility (IV). We also find that the TS strategy outperforms (underperforms) the CS strategy in market continuations (transitions) consistent with the recent evidence in the U.S. market. Furthermore, we find that CS and TS strategies of both Islamic and Non-Islamic stocks are profitable only when the market continues in the same state consistent with overconfidence driving momentum returns of both Islamic and Non-Islamic stocks.
    Keywords: Islamic stocks, cross-sectional, time-series, momentum returns, market dynamics
    JEL: G11 G12 G14
    Date: 2017–11–01

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