nep-fmk New Economics Papers
on Financial Markets
Issue of 2019‒02‒25
eleven papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Volatility, Valuation Ratios, and Bubbles: An Empirical Measure of Market Sentiment By Gao, Can; Martin, Ian
  2. Factor Momentum and the Momentum Factor By Sina Ehsani; Juhani T. Linnainmaa
  3. The Endowment Model and Modern Portfolio Theory By Stephen G. Dimmock; Neng Wang; Jinqiang Yang
  4. Is Gold a Safe Haven? International Evidence revisited By Bulut, Levent; Rizvanoghlu, Islam
  5. Credit Ratings and Structured Finance By Josephson, Jens; Shapiro, Joel
  6. Tranched Value Securities By Zvezdin, Nikolay
  7. The Long and Short of It: The Post-Crisis Corporate CDS Market By Boyarchenko, Nina; Costello, Anna; Shachar, Or
  8. Correlation Patterns in Foreign Exchange Markets By Lasko Basnarkov; Viktor Stojkoski; Zoran Utkovski; Ljupco Kocarev
  9. Sovereign Bonds since Waterloo By Josefin Meyer; Carmen M. Reinhart; Christoph Trebesch
  10. Chinese Bond Market and Interbank Market By Marlene Amstad; Zhiguo He
  11. The Impact of Shanghai-Hong Kong Stock Connect on the Effectiveness of Price Limits in the Chinese Stock Market By Chong, Terence Tai Leung; Kwok, Stanley

  1. By: Gao, Can; Martin, Ian
    Abstract: We define a sentiment indicator that exploits two contrasting views of return predictability, and study its properties. The indicator, which is based on option prices, valuation ratios and interest rates, was unusually high during the late 1990s, reflecting dividend growth expectations that in our view were unreasonably optimistic. We interpret it as helping to reveal irrational beliefs about fundamentals. We show that our measure is a leading indicator of detrended volume, and of various other measures associated with financial fragility. We also make two methodological contributions. First, we derive a new valuation-ratio decomposition that is related to the Campbell and Shiller (1988) loglinearization, but which resembles the traditional Gordon growth model more closely and has certain other advantages for our purposes. Second, we introduce a volatility index that provides a lower bound on the market's expected log return.
    Keywords: bubbles; Option prices; sentiment; valuation ratios; volatility
    JEL: G10 G12 G14
    Date: 2019–01
  2. By: Sina Ehsani; Juhani T. Linnainmaa
    Abstract: Momentum in individual stock returns emanates from momentum in factor returns. Most factors are positively autocorrelated: the average factor earns a monthly return of 1 basis point following a year of losses and 53 basis points following a positive year. Factor momentum explains all forms of individual stock momentum. Stock momentum strategies indirectly time factors: they profit when the factors remain autocorrelated, and crash when these autocorrelations break down. Our key result is that momentum is not a distinct risk factor; it aggregates the autocorrelations found in all other factors.
    JEL: G11 G12
    Date: 2019–02
  3. By: Stephen G. Dimmock; Neng Wang; Jinqiang Yang
    Abstract: We develop a dynamic portfolio-choice model with illiquid alternative assets to analyze conditions under which the “Endowment Model,” used by some large institutional investors such as university endowments, does or does not work. The alternative asset has a lock-up, but can be voluntarily liquidated at any time at a cost. Quantitatively, our model's results match the average level and cross-sectional variation of university endowment funds' spending and asset allocation decisions. We show that asset allocations and spending crucially depend on the alternative asset's expected excess return, risk unspanned by public equity, and investors' preferences for inter-temporal spending smoothing.
    JEL: G11 G23
    Date: 2019–02
  4. By: Bulut, Levent; Rizvanoghlu, Islam
    Abstract: The literature has not settled down on safe haven property of gold in emerging and developing countries. Therefore, in this study, we revisit the international evidence on hedging and safe haven role of gold for 34 emerging and developing countries with a span of daily data covering January 2000 – November 2018. We employ GARCH-copula approach to estimate lower-tail extreme dependencies of the joint distribution of gold and equity returns. We also introduce a new definition for strong safe haven property of an asset. Our findings indicate that while gold serves as a hedge instrument for all countries in our sample, we got evidence of weak safe haven property for gold, for domestic investors, only in 18 countries, and a strong safe haven asset only in six countries.
    Keywords: gold emerging markets copula tail dependence safe haven
    JEL: C58 F30 G10 G15
    Date: 2019–01–20
  5. By: Josephson, Jens; Shapiro, Joel
    Abstract: The poor performance of credit ratings of structured finance products in the financial crisis has prompted investigation into the role of credit rating agencies (CRAs) in designing and marketing these products. We analyze a two-period reputation model in which a CRA both designs and rates securities that are sold both to investors who are constrained to purchase highly rated securities and investors who are unconstrained. Assets are pooled and senior and junior tranches are issued with a waterfall structure. When the rating constraint is lax, the CRA will include only risky assets in the securitization pool, serving both types of investors without any rating inflation. Rating inflation is decreasing in the tightness of the rating constraint locally. But rating inflation may be non-monotonic in the rating constraint globally, with no rating inflation when the constraint is lax or tight.
    Keywords: Credit rating agencies; reputation; Structured finance
    JEL: G24 L14
    Date: 2019–02
  6. By: Zvezdin, Nikolay
    Abstract: Structured financial products and derivatives were one of the major financial innovations since 18th century, which improve market completeness by transforming risk-sharing mechanisms. Since then, thousands of derivative types were created, and its market has grown to over six-times greater than global GDP, but capital markets still exhibit efficiency only to a limited extent. This paper assesses the potential performance of Tranched Value Securities (patent pending) – a new financial instrument that transforms a single underlying to asymmetrically paying derivative, and has a potential to further improve capital markets by facilitating risk sharing, and satisfy a wide range of investment objectives.
    Keywords: tranched value securities; value tranching; derivatives; securitization; risk transfer; financial instrument; structured products; securities; alternative investments; financial innovation
    JEL: G0 G00 G10 G12 G13 G19
    Date: 2019–02–19
  7. By: Boyarchenko, Nina; Costello, Anna; Shachar, Or
    Abstract: The 2007-2009 financial crisis highlighted the vulnerability of financial institutions linked by a complex web of credit default swap (CDS) contracts, sparking a wave of regulatory changes to the structure of the market. In this paper, we provide broad evidence on the evolution of the CDS market in the post-crisis period, document the properties of participants' exposures to corporate CDS over time, and study the differential pricing of transactions between different types of counterparties.
    Keywords: CDS positions; CDS transactions; dealer market power
    JEL: G10 G12 G19
    Date: 2019–02
  8. By: Lasko Basnarkov; Viktor Stojkoski; Zoran Utkovski; Ljupco Kocarev
    Abstract: The value of an asset in a financial market is given in terms of another asset known as numeraire. The dynamics of the value is non-stationary and hence, to quantify the relationships between different assets, one requires convenient measures such as the means and covariances of the respective log returns. Here, we develop transformation equations for these means and covariances when one changes the numeraire. The results are verified by a thorough empirical analysis capturing the dynamics of numerous assets in a foreign exchange market. We show that the partial correlations between pairs of assets are invariant under the change of the numeraire. This observable quantifies the relationship between two assets, while the influence of the rest is removed. As such the partial correlations uncover intriguing observations which may not be easily noticed in the ordinary correlation analysis.
    Date: 2019–02
  9. By: Josefin Meyer; Carmen M. Reinhart; Christoph Trebesch
    Abstract: This paper studies external sovereign bonds as an asset class. We compile a new database of 220,000 monthly prices of foreign-currency government bonds traded in London and New York between 1815 (the Battle of Waterloo) and 2016, covering 91 countries. Our main insight is that, as in equity markets, the returns on external sovereign bonds have been sufficiently high to compensate for risk. Real ex-post returns averaged 7% annually across two centuries, including default episodes, major wars, and global crises. This represents an excess return of around 4% above US or UK government bonds, which is comparable to stocks and outperforms corporate bonds. The observed returns are hard to reconcile with canonical theoretical models and with the degree of credit risk in this market, as measured by historical default and recovery rates. Based on our archive of more than 300 sovereign debt restructurings since 1815, we show that full repudiation is rare; the median haircut is below 50%.
    Keywords: sovereign debt, default, risk premiums, investor returns, interest rates, portfolio, yields, coupons, recovery
    JEL: E40 F30 F40 G10 N00
    Date: 2019
  10. By: Marlene Amstad; Zhiguo He
    Abstract: Over the past twenty years, especially the past decade, China has taken enormous strides to develop its bond market as an integral step of financial reform. This paper aims to provide the most up-to-date overview of Chinese bond markets, by highlighting two distinct and largely segmented markets: Over-the-Counter based interbank market, and centralized exchange market. We explain various bond instruments traded in these two markets, highlighting their inherent connection with the banking system, and many multi-layer regulatory bodies who are interacting with each other in an intricate way. We also covers the credit ratings and rating agencies in Chinese market, and offer an account of ever-rising default incidents in China starting 2014. Finally, we discuss the recent regulatory tightening of shadow banking since late 2017 and its impact on bond investors, and the forces behind the internalization of Chinese bond markets in the near future.
    JEL: F4 G2 O16 O2 O53
    Date: 2019–02
  11. By: Chong, Terence Tai Leung; Kwok, Stanley
    Abstract: Launched in 2014, the Shanghai-Hong Kong Stock Connect (SHSC) is the first mutual access channel between the Chinese and Hong Kong equity markets. The scheme allows Hong Kong and international investors to purchase eligible Shanghai-listed shares, while at the same time permitting eligible Chinese investors to purchase eligible Hong Kong-listed shares. This paper aims to examine the impact of the scheme on the effectiveness of the price limit rule, which is only imposed in China but not in Hong Kong. Results show that the scheme alleviates the delayed price discovery problem caused by price limits but has no significant effect on the problems of volatility spillover and trading interference.
    Keywords: Stock Connect; Price Limits; Price Discovery
    JEL: G14 G15 G18
    Date: 2019–02–14

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