nep-fmk New Economics Papers
on Financial Markets
Issue of 2018‒02‒26
seven papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. The Effect of Investment Constraints on Hedge Fund Investor Returns By Joenväärä, Juha; Kosowski, Robert; Tolonen, Pekka
  2. Yield Curve Flattening a Symptom of Ineffective Policy Tightening By Xing, Victor
  3. Sovereign bond-backed securities: a VAR-for-VaR and Marginal Expected Shortfall assessment By Maite De Sola Perea; Peter G. Dunne; Martin Puhl; Thomas Reininger
  4. Original sin in corporate finance: New evidence from Asian bond issuers in onshore and offshore markets By Paul Mizen; Frank Packer; Eli Remolona; Serafeim Tsoukas
  5. Positive liquidity spillovers from sovereign bond-backed securities By Peter G. Dunne
  6. Searching for yield abroad: risk-taking through foreign investment in U.S. bonds By John Ammer; Alexandra Tabova; Caleb Wroblewski
  7. Why Has the Stock Market Risen So Much Since the US Presidential Election? By Olivier J Blanchard; Christopher G. Collins; Mohammad R. Jahan-Parvar; Thomas Pellet; Beth Anne Wilson

  1. By: Joenväärä, Juha; Kosowski, Robert; Tolonen, Pekka
    Abstract: This paper examines the effect of investor-level real-world investment constraints, including several which had not been studied before, on hedge fund performance and its persistence. Using a large consolidated database, we demonstrate that hedge fund performance persistence is significantly reduced when rebalancing rules reflect fund size restrictions and liquidity constraints, but remains statistically significant at higher rebalancing frequencies. Hypothetical investor portfolios that incorporate additional minimum diversification constraints, minimum investment requirements, and focus on open funds suggest that the performance and its persistence documented in earlier studies of hedge funds is not easily exploitable, especially by large investors.
    Keywords: frictions; Hedge Fund Performance; Managerial Skill; Persistence
    JEL: G11 G12 G23
    Date: 2018–01
  2. By: Xing, Victor
    Abstract: Executive summary: • A flattening yield curve highlights Federal Reserve rate hikes’ inability to tighten financial conditions, as low long-term interest rates continued to induce institutional investors to “reach for yield” by moving up the risk ladder • Central banks initiating “short volatility positions” via QE have dampened long-term sovereign bond yields, which crowded out private capital and induced investors to “find something else to do” by buying more esoteric assets • A flat yield curve alone would only pave the way, rather than directly trigger events that result in recession, as persistently low long-term bond yields increase the probability and magnify the impacts of balance sheet crises • Prolonged easy financial conditions as a result of ineffective tightening is not costless, for uneven wage growth and rapid asset price appreciation have exacerbated inequality to heighten financial, social and political instability
    Keywords: Yield curve, monetary policy, balance sheet normalization, quantitative easing
    JEL: E0 E5 G12
    Date: 2018–01–07
  3. By: Maite De Sola Perea; Peter G. Dunne; Martin Puhl; Thomas Reininger
    Abstract: The risk reducing benefits of the sovereign bond-backed security (SBBS) proposal of Brunnermeier et al (2011, 2016, 2017) have been assessed in terms of the likely losses that different kinds of holders would suffer under simulated default scenarios. However, the effects of mark-to-market losses that may occur when there is rising uncertainty about defaults, or when self-fulfilling destablising dynamics are prevalent, have not yet been examined. We apply the “VAR-for-VaR” method of White, Kim and Manganelli (2015) and the Marginal Expected Shortfall approach of Brownlees and Engle (2012, 2017) to estimated yields of SBBS to assess how ex ante exposures are likely to playout under various securitisation structures. We compare these with exposures of single sovereigns and a diversified portfolio. We find that the senior SBBS has extremely low ex ante tail risk and that, like the lowest-risk single-named sovereigns, it acts as a hedge against extreme adverse movements in the yields on more junior tranches. The mezzanine SBBS has tail risk exposure similar to that of Italian and Spanish bonds. Yields on SBBS appear to be adequate compensation for their risks when compared with single sovereigns or a diversified portfolio. JEL Classification: E43, E44, E52, E53, G12, G14
    Keywords: Safe Assets; Sovereign Bonds; Value-at-Risk; Spillover; CAViaR; Co-Dependence
    Date: 2018–01
  4. By: Paul Mizen; Frank Packer; Eli Remolona; Serafeim Tsoukas
    Abstract: We borrow from the literature on sovereign debt finance the idea of “original sin” and redefine it for use in corporate finance. In its new incarnation, original sin refers to the difficulty firms in many emerging markets have in borrowing domestically long-term, even in the local currency. We infer the nature of original sin from 5,500 financing decisions by firms in seven Asian emerging markets over a period of 11 years. Our sample period covers an episode when bond issuers had a choice between a less developed but growing onshore market, which varied across countries in the level of development, and a deep and liquid offshore market. We find that even in countries with onshore markets, it is often easier for unseasoned firms to issue offshore (in foreign currency) than to issue onshore, but structural change brought about by market development reverses this effect. In addition, once such a firm becomes a seasoned issuer, it is absolved from domestic original sin and is then able to act opportunistically and go to the market favoured by interest differentials.
    Keywords: bond financing; offshore markets; emerging markets; market depth; global credit
    Date: 2018
  5. By: Peter G. Dunne
    Abstract: There are competing arguments about the likely effects of Sovereign Bond-Backed Securitisation on the liquidity of sovereign bond markets. By analysing hedging and diversification opportunities, this paper shows that positive liquidity spillovers would dominate or at least constrain the extent of any negative effects. This relies on dealers using Sovereign Bond-Backed Securities as instruments to hedge inventory risk and it assumes that they diversify their activities widely across euro area sovereign markets. Through a simple arbitrage relation, the existence of low-cost hedging and diversification opportunities limits the divergence of bid-ask spreads between national and SBBS markets. This is demonstrated using estimated SBBS yields (` la Sch¨nbucher (2003)). JEL Classification: E44, G12, G24, C22, C53, C58, C63
    Keywords: Safe Assets, Securitsation, Dealer Behaviour, Liquidity Bid-Ask Spread
    Date: 2018–01
  6. By: John Ammer; Alexandra Tabova; Caleb Wroblewski
    Abstract: The risk-taking effects of low interest rates, now prevailing in many advanced countries, ("search-for-yield") are hard to analyze due to both a paucity of data and challenges in identification. Unique, security-level data on portfolio investment into the United States allow us to overcome both problems. Analyzing holdings of investors from 36 countries in close to 15,000 unique U.S. corporate bonds between 2003 and 2016, we show that declining home-country interest rates lead investors to shift their international bond portfolios toward riskier U.S. corporate bonds, consistent with "search-for-yield". We estimate even stronger effects when home interest rates reach a low level, suggesting that risk-taking in securities accelerates as rates decline.
    Keywords: low interest rates, search for yield, portfolio choice, corporate debt
    JEL: F21 F34 G11 G20
    Date: 2018–01
  7. By: Olivier J Blanchard (Peterson Institute for International Economics); Christopher G. Collins (Federal Reserve Board of Governors); Mohammad R. Jahan-Parvar (Federal Reserve Board of Governors); Thomas Pellet (Peterson Institute for International Economics); Beth Anne Wilson (Federal Reserve Board of Governors)
    Abstract: Immediately following the US presidential election in November 2016, many economists were concerned that increased uncertainty over economic policy would lead to a decline in the US stock market. From the time of the election to the end of 2017, however, the stock market, as measured by the Standard and Poor's (S&P) 500 index, increased by about 25 percent. Price swings since then have led investors and economists to increasingly ask: Was the stock market rise justified by an increase in actual and expected future dividends, or did it reflect unhealthy price developments, which may reverse in the future? This Policy Brief examines the movement of stock market prices from the time of the election to the end of 2017. It concludes that a bit more than one half of the run-up in the S&P 500 can be explained by an increase in actual and expected dividends. The effects of the perceived probability that a corporate tax cut bill would pass Congress account for 2 to 6 percentage points of this increase. The rest can be attributed to a decrease of less than 100 basis points in the equity premium, a decrease that leaves it roughly equal to where it was in the mid-2000s. Lower uncertainty in the rest of the world, in particular in Europe, more than offset the higher policy uncertainty in the United States following the 2016 presidential election and can plausibly justify this decrease in the equity premium.
    Date: 2018–02

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