nep-fmk New Economics Papers
on Financial Markets
Issue of 2018‒07‒23
six papers chosen by

  1. Introducing shrinkage in heavy-tailed state space models to predict equity excess returns By Florian Huber; Gregor Kastner
  2. The Term Structure of Variance Swaps and Risk Premia By Yacine Ait-Sahalia; Mustafa Karaman; Loriano Mancini
  3. Market Structure and Transaction Costs of Index CDSs By Pierre Collin-Dufresne; Benjamin Junge; Anders B. Trolle
  4. Testing for time-varying stochastic volatility in Bitcoin returns By Afees A. Salisu; Idris Adediran
  5. Is VIX still the investor fear gauge? Evidence for the US and BRIC markets By Marco Neffelli; Marina Resta
  6. Demand For Stocks in the Crisis: France 2004-2014 By Luc Arrondel; Jérôme Coffinet

  1. By: Florian Huber; Gregor Kastner
    Abstract: We forecast S&P 500 excess returns using a flexible econometric state space model with non-Gaussian features at several levels. Estimation and prediction are conducted using fully-fledged Bayesian techniques. More precisely, we control for overparameterization via novel global-local shrinkage priors on the state innovation variances as well as the time-invariant part of the state space model. The shrinkage priors are complemented by heavy tailed state innovations that cater for potential large swings in the latent states even if the amount of shrinkage introduced is high. Moreover, we allow for leptokurtic stochastic volatility in the observation equation. The empirical findings indicate that several variants of the proposed approach outperform typical competitors frequently used in the literature, both in terms of point and density forecasts. Furthermore, a simple trading exercise shows that our framework also fares well when used for investment decisions.
    Date: 2018–05
  2. By: Yacine Ait-Sahalia (Princeton University and National Bureau of Economic Research (NBER)); Mustafa Karaman (University of Zurich); Loriano Mancini (University of Lugano and Swiss Finance Institute)
    Abstract: We study the term structure of variance swaps, equity and variance risk premia. A model-free analysis reveals a significant price jump component in variance swap rates. A model-based analysis shows that investors' willingness to ensure against volatility risk increases after a market drop. This effect is stronger for short horizons and more persistent for long horizons. During the financial crisis investors demanded large risk premia to hold equities but the risk premia largely depended and strongly decreased with the holding horizon. The term structure of equity and variance risk premia responds differently to various economic indicators.
    Keywords: Variance Swap, Stochastic Volatility, Likelihood Approximation, Term Structure, Equity Risk Premium, Variance Risk Premium
    JEL: C51 G12 G13
    Date: 2018–05
  3. By: Pierre Collin-Dufresne (Ecole Polytechnique Fédérale de Lausanne, Swiss Finance Institute, and National Bureau of Economic Research (NBER)); Benjamin Junge (Ecole Polytechnique Fédérale de Lausanne); Anders B. Trolle (HEC Paris)
    Abstract: Despite a regulatory effort to promote all-to-all trading, the post-Dodd-Frank index-CDS market remains two-tiered. Dealer-to-client trades have higher transaction costs than interdealer trades. The difference is entirely explained by the higher, largely permanent, price impact of client trades. However, transaction costs of interdealer trades vary significantly across trading protocols. Mid-market matching and workup -- both characterized by execution risk -- incur the smallest costs. Dealer-to-client trades typically execute well inside the spread quoted on the interdealer limit order book. Thus, clients who value immediacy could not improve execution with marketable interdealer orders. This may explain the endurance of the two-tiered market structure.
    Keywords: CDX, Dodd-Frank Act, Market Structure, Transaction Costs, Swap Execution Facility, Trading Protocols, Workup
    JEL: G12 G13 G14 G28
    Date: 2018–06
  4. By: Afees A. Salisu (Department for Management of Science and Technology Development, Ton Duc Thang University, Ho Chi Minh City, Vietnam Faculty of Business Administration, Ton Duc Thang University, Ho Chi Minh City, Vietnam Centre for Econometric and Allied Research, University of Ibadan); Idris Adediran (Department of Economics, Obafemi Awolowo University, Nigeria.)
    Abstract: The study will be the first to offer empirical justification for time-varying stochastic volatility in Bitcoin returns. Specifically, it tests for time variation in both the trend and transitory components of the stochastic volatility using the unobserved components model that accounts for same. Thereafter, it calculates the Bayes factor using the approach of Chan (2018) which involves the Savage-Dickey density ratio in order to avoid the computation of the marginal likelihood. The results overwhelmingly support at least one time-varying stochastic volatility component in Bitcoin returns and the transitory component is favoured in this regard. These results are robust to different data frequencies.
    Keywords: Bitcoin returns, Time-varying stochastic volatility, Bayes factor
    JEL: C11 C53 G17
    Date: 2018–07
  5. By: Marco Neffelli; Marina Resta
    Abstract: We investigate the relationships of the VIX with US and BRIC markets. In detail, we pick up the analysis from the point left off by (Sarwar, 2012), and we focus on the period: Jan 2007 - Feb 2018, thus capturing the relations before, during and after the 2008 financial crisis. Results pinpoint frequent structural breaks in the VIX and suggest an enhancement around 2008 of the fear transmission in response to negative market moves; largely depending on overlaps in trading hours, this has become even stronger post-crisis for the US, while for BRIC countries has gone back towards pre-crisis levels.
    Date: 2018–06
  6. By: Luc Arrondel (PSE - Paris School of Economics, PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique); Jérôme Coffinet (Banque de France - Banque de France)
    Abstract: In this paper, we assess how the factors explaining the holdings of stocks have evolved through the financial crisis. We rely on the data collected in surveys conducted among French households during the period 2004-2014. There are three main modes for investing in stocks: buying shares directly; purchasing them through mutual funds; and finally taking out unitlinked life insurance. Obviously, these three ways to invest in stocks do not involve the same investment behaviours since, besides the risk and return characteristics, they differ in their transaction costs, management fees and taxation. As a result, there is no a priori reason to consider that portfolio choice decisions by households on these modes of stockownership are equivalent and correspond to the same individuals' characteristics. We show that the holding of risky assets and of individual direct shares decreased during the period, and especially between 2009 and 2014. At the end of the period, the profile of direct equity holders was refocused towards profiles with greater risk tolerance. Other factors of direct stockholdings include: better education, gifts and inheritances, parents holding securities, singles, high-wealth households and high-income groups. Conditionally on holdings, the proportion of risky assets increases with risk tolerance and the holding of securities by parents. It also decreases at the end of the period. Our paper also shows that shareholders have gradually moved towards preferential ownership of shares in life insurance rather than direct share ownership, especially between 2009 and 2014. The estimation of a simultaneous model shows the specific characteristics of stockholders depending on the chosen support (direct, indirect or on life insurance): those who invest directly in stocks are richer, more educated and less risk averse; those who hold mutual funds are a little richer but more risk averse and do not appear the most educated; finally, for ownership in stocks on life insurance contracts, the position in the life cycle plays an important role as well as the social category.
    Date: 2018–05

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