nep-fmk New Economics Papers
on Financial Markets
Issue of 2019‒01‒28
ten papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Have Hedge Funds Solved the Idiosyncratic Volatility Puzzle? By Turan G. Bali; Florian Weigert;
  2. Unobserved Performance of Hedge Funds By Vikas Agarwal; Stefan Ruenzi; Florian Weigert;
  3. Price effect of mutual fund flows on the corporate bond market. The French case By Virginie Coudert; Dilyara Salakhova
  4. Volatility and Informativeness By Eduardo Dávila; Cecilia Parlatore
  5. Media Sentiment and International Asset Prices By Samuel P. Fraiberger; Do Lee; Damien Puy; Romain Ranciere
  6. Gains from Policy Cooperation in Capital Controls and Financial Market Incompleteness By Shigeto Kitano; Kenya Takaku
  7. A Simple Macro-Finance Measure of Risk Premia in Fed Funds Futures By Anthony M. Diercks; Uri Carl
  8. Equity finance and capital market integration in Europe By Inês Goncalves Raposo; Alexander Lehmann
  9. Trading Volume, Illiquidity and Commonalities in FX Markets By Angelo Ranaldo; Paolo Santucci de Magistris; ;
  10. China's Bond Market and Global Financial Markets By Eugenio M Cerutti; Maurice Obstfeld

  1. By: Turan G. Bali; Florian Weigert;
    Abstract: This paper examines idiosyncratic volatility of equity-oriented hedge funds and provides an explanation for why there exists a positive cross-sectional relation between funds’ idiosyncratic volatility and their future returns, whereas higher idiosyncratic volatility predicts lower returns in the cross-section of individual stocks. We find that idiosyncratic volatility is a persistent hedge fund characteristic and positively linked to proxies for managerial incentives, discretion, and leverage. Moreover, funds with a greater value of long call options and confidential equity positions disclosed with a delay in their regulatory filings exhibit higher idiosyncratic volatility. We document a positive (negative) cross-sectional relation between idiosyncratic volatility and future returns on individual stocks with high (low) hedge fund ownership. The results indicate that hedge funds are able to solve the idiosyncratic volatility puzzle by successfully picking undervalued, high-volatility stocks that offer high future returns and shying away from overvalued, high-volatility and lottery-like stocks that offer low future returns.
    Keywords: Hedge Funds, Idiosyncratic Volatility Puzzle, Confidential Holdings, Derivatives, Managerial Incentives, Investment Performance
    JEL: G11 G23
    Date: 2018–12
  2. By: Vikas Agarwal; Stefan Ruenzi; Florian Weigert;
    Abstract: We investigate hedge funds’ unobserved performance (UP), measured as the risk-adjusted return difference between a fund firm’s reported return and the hypothetical portfolio return derived from its disclosed long equity holdings. We find that high UP is (i) positively associated with measures of managerial incentives, discretion, and skill, and (ii) driven by a fund firm’s frequent trading in equity positions, derivatives usage, short selling, and confidential holdings. Fund firms with high UP outperform fund firms with low UP by more than 6% p.a. after accounting for typical hedge fund risk factors and fund characteristics.
    Keywords: Confidential Holdings, Derivative Usage, Discretion, Frequent Trading, Hedge Funds, Managerial Incentives, Short Selling, Unobserved Performance
    JEL: G11 G23
    Date: 2018–12
  3. By: Virginie Coudert; Dilyara Salakhova
    Abstract: We study how investors' withdrawals from mutual funds may affect the French corporate bond market. To do so, we use monthly data on flows to the French bond and mixed mutual funds as well as a database on their bond holdings at the bond-level from 2011 to 2017 provided by the Banque of France Statistics Department. Using a large sample of French corporate bonds held by funds, we run panel data regressions at the bond-level to explain their yields by macroeconomic variables, such as the sovereign 10-y rate, the short-term rate, the Vstoxx as well as bond-specific variables, such as the residual maturity, liquidity and the issuer’s probability of default. We also account for the corporate securities purchasing programme (CSPP) implemented by the ECB since June 2016 by adding dummy variables on the eligible bonds. Then we add variables related to inflows/outflows to test for several hypotheses. First, our results show that flows to funds affect the yields of all corporate bonds across the board. Second, this effect is asymmetric since outflows have a greater impact on yields than inflows. Third, the greater the funds’ market share in a specific bond the higher the impact on this bond is. These three results are robust to change in econometric specification. Further estimations suggest that withdrawals may raise liquidity premia and ownership by funds could amplify the response of bond yields to financial stress, although these two latter results are not significant in all econometric specifications.
    Keywords: investment funds, bond holdings, bond yields, fund flows, financial stability
    JEL: G12 G23
    Date: 2019
  4. By: Eduardo Dávila; Cecilia Parlatore
    Abstract: We explore the equilibrium relation between price volatility and price informativeness in financial markets, with the ultimate goal of characterizing the type of inferences that can be drawn about price informativeness by observing price volatility. We identify two different channels (noise reduction and equilibrium learning) through which changes in price informativeness are associated with changes in price volatility. We show that when informativeness is sufficiently high (low) volatility and informativeness positively (negatively) comove in equilibrium for any change in primitives. In the context of our leading application, we provide conditions on primitives that guarantee that volatility and informativeness always comove positively or negatively. We use data on U.S. stocks between 1963 and 2017 to recover stock-specific primitives and find that most stocks lie in the region of the parameter space in which informativeness and volatility comove negatively.
    JEL: D82 D83 G14
    Date: 2019–01
  5. By: Samuel P. Fraiberger; Do Lee; Damien Puy; Romain Ranciere
    Abstract: We assess the impact of media sentiment on international equity prices using more than 4.5 million Reuters articles published across the globe between 1991 and 2015. News sentiment robustly predicts daily returns in both advanced and emerging markets, even after controlling for known determinants of stock prices. But not all news-sentiment is alike. A local (country-specific) increase in news optimism (pessimism) predicts a small and transitory increase (decrease) in local returns. By contrast, changes in global news sentiment have a larger impact on equity returns around the world, which does not reverse in the short run. We also find evidence that news sentiment affects mainly foreign – rather than local – investors: although local news optimism attracts international equity flows for a few days, global news optimism generates a permanent foreign equity inflow. Our results confirm the value of media content in capturing investor sentiment.
    Keywords: International financial markets;Capital flows;Asset Pricing, Behavioral Finance, Investor Sentiment, News Media, Natural Language Processing
    Date: 2018–12–10
  6. By: Shigeto Kitano (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan); Kenya Takaku (Faculty of International Studies, Hiroshima City University, Japan)
    Abstract: We examine how the degree of financial market incompleteness affects welfare gains from policy cooperation in capital controls. When financial markets are incomplete, international risk sharing is disturbed. However, the optimal global policy significantly reverses the welfare deterioration due to inefficient risk-sharing. We find that when financial markets are more incomplete, the welfare gap between the optimal global policy and the Nash equilibrium increases, and the welfare gains from policy cooperation in capital controls then become larger.
    Keywords: Financial markets; Incomplete markets; Policy cooperation; Capital controls; Optimal policy; Welfare; Ramsey policy; Open-loop Nash game
    JEL: D52 E61 F32 F42 G15
    Date: 2019–01
  7. By: Anthony M. Diercks; Uri Carl
    Abstract: In this Note, we use rolling covariances between real and nominal activity in a regression framework, combined with a model averaging approach, to uncover intuitive dynamics in the term premium.
    Date: 2019–01–08
  8. By: Inês Goncalves Raposo; Alexander Lehmann
    Abstract: This material was originally published in a study commissioned by the European Commission’s Directorate-General for Financial Stability, Financial Services and Capital Markets Union. The opinions expressed in this document are the sole responsibility of the authors and do not necessarily represent the official position of the European Commission. The study is available on the European Commission’s webpage . ©European Union, 2018. Facilitating the financing of European companies through external equity is a central ambition of European Union financial regulation, including in the European Commission’s capital markets union agenda. An emphasis on equity is justified because Europe’s companies remain vulnerable because they hold excess debt and reliance on bank finance will make capital expenditures highly cyclical. Also, equity investors mobilise operational and corporate governance reforms within investee firms that lift firm productivity. The share of listed equity in the total balance sheets of EU non-financial companies has expanded, though this is limited to the core euro area, and to large companies. While net funding from listed equity issuance has declined, private equity has rapidly expanded and is back at pre-crisis levels. This is a welcome development because, compared to public equity, private equity is accessed by a wider range of smaller companies. Firm-level data suggests that the use of external equity is still relatively exceptional. The share of firms using external equity has dropped since the immediate aftermath of the financial crisis, when loan conditions tightened. Although overall financing conditions have improved, the perceived gap between needs and availability of equity financing has not narrowed. The United Kingdom is Europe’s most advanced equity market; other EU countries are considerably less attractive to private equity investors, and there have been no improvements in key policy areas. Specifically, corporate governance practices, such as the rights of minority shareholders, remain an obstacle and underline a reluctance to dilute the control of established owners. Private equity activity in the EU still shows a strong home bias. Fundraising from outside the private equity firm’s home base, and eventual divestment outside national capital markets, have become marginally more significant, though overall remain quite limited. Government agencies still play an important role in funding, and smaller countries remain particularly constrained by local capital markets. The European regulation of private equity reflects post-crisis concerns about financial stability risks that are largely unjustified by the industry’s business model. Fragmentation of supervision further complicates cross-border distribution of funds. The exit from the single market of the UK as the home of nearly half the European investor base poses a serious threat to equity funding in the EU. In the context of further capital markets union legislation, the EU should consider greater risk tolerance and harmonised capital requirements.
    Date: 2019–01
  9. By: Angelo Ranaldo; Paolo Santucci de Magistris; ;
    Abstract: We provide a unified model for foreign exchange (FX), trading volume, and volatility in a multi-currency environment. Tied by arbitrage conditions, FX rates are determined by common information and trader-specific components generating heterogeneous reservation prices thus inducing trading. Our model outlines new properties including volume-volatility relationships between direct and synthetic FX rates. It also provides a theoretical foundation for commonalities of volume, volatility, and illiquidity across currencies and time, and an intuitive closed-form solution for the price impact measure. Using unique (intraday) data representative for the global FX spot market, the empirical analysis validates our theoretical predictions.
    Keywords: FX Trading Volume, Volatility, Illiquidity, MDH, Commonalities, Co-Jumps
    JEL: C15 F31 G12 G15
    Date: 2018–11
  10. By: Eugenio M Cerutti; Maurice Obstfeld
    Abstract: A cross-country comparative analysis shows that there is substantial room for further integration of China into global financial markets, especially in the case of the international bond market. A further successful liberalization of the Chinese bond market would encompass not only loosening bond market regulations, but also further developing of other markets, notably the foreign exchange market. Even though the increased integration of China into international capital markets would increase its exposure to the global financial cycle, the costs in terms of monetary autonomy would not be large given China’s size and especially under a well-articulated macroeconomic framework.
    Keywords: Globalization;Asia and Pacific;China;International financial markets;Bond Market, Market Integration, Financial Aspects of Economic Integration, International Business Cycles
    Date: 2018–12–07

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