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on Financial Markets |
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Issue of 2019‒04‒22
eight papers chosen by |
| By: | Kelly Shue; Richard R. Townsend |
| Abstract: | Nominal stock prices are arbitrary. Therefore, when evaluating how a piece of news should affect the price of a stock, rational investors should think in percentage rather than dollar terms. However, dollar price changes are ubiquitously reported and discussed. This may both cause and reflect a tendency of investors to think about the impact of news in dollar terms, leading to more extreme return responses to news for lower-priced stocks. We find a number of results consistent with such non-proportional thinking. First, lower-priced stocks have higher total volatility, idiosyncratic volatility, and market betas, after controlling flexibly for size. To identify a causal effect of price, we show that volatility increases sharply following pre-announced stock splits and drops following reverse stock splits. The returns of lower-priced stocks also respond more strongly to firm-specific news events, all else equal. The economic magnitudes are large: a doubling in a stock's nominal price is associated with a 20-30% decline in its volatility, beta, and return response to firm-specific news. These patterns are not exclusive to small, illiquid stocks; they hold even among the largest stocks. Non-proportional thinking can explain a variety of asset pricing anomalies such as long-run and short-run reversals, as well as the negative relation between past returns and volatility (i.e., the leverage effect). Our analysis also shows that the well-documented negative relation between risk (volatility or beta) and size is actually driven by nominal prices rather than fundamentals. |
| JEL: | D03 D9 D91 G02 G12 G14 |
| Date: | 2019–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:25751&r=all |
| By: | Ben-David, Itzhak (Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER)); Li, Jiacui (Stanford University, Graduate School of Business, Students); Rossi, Andrea (University of Arizona - Department of Finance); Song, Yang (University of Washington - Department of Finance and Business Economics) |
| Abstract: | Rational investors should account for risk factor exposure when allocating capital to mutual funds. Two recent influential studies use mutual fund flows to test whether investors distinguish between performance driven by managers' skill and systematic risk factors. Both studies found that investors use the Capital Asset Pricing Model (CAPM), and one concluded that the CAPM is the "closest to the true asset pricing model." We re-examine these results and show that, in fact, fund flow data are most consistent with investors relying blindly on fund rankings (specifically, Morningstar ratings) and chasing recent returns. We find no evidence that investors account for any of the common systematic risk factors when allocating capital among mutual funds. |
| JEL: | G11 G12 |
| Date: | 2019–03 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:ohidic:2019-5&r=all |
| By: | Werner, Ingrid M. (The Ohio State University - Fisher College of Business); Wen, Yuanji (The University of Western Australia - Department of Accounting and Finance); Rindi, Barbara (Bocconi University and IGIER and Baffi Carefin); Buti, Sabrina (Université Paris Dauphine - Department of Finance) |
| Abstract: | We model a public limit order book (PLB) with rational investors choosing to supply or demand liquidity. Following a reduction in the tick size the effects on PLB’s market quality depend on the liquidity of the stocks. Spread improves for tick-constrained stocks and deteriorates for unconstrained stocks; inside depth decreases in particular for constrained stocks, and volume increases for unconstrained stocks. The model also shows how results change when competition from a crossing network generates order flow migration. We find empirical support for these predictions by exploiting the 2014 reduction of tick size at the Tokyo Stock Exchange. |
| JEL: | D40 G10 G20 G24 |
| Date: | 2019–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:ohidic:2019-03&r=all |
| By: | Yang-Ho Park |
| Abstract: | Using positions data on bond futures, I document that speculators' spread trades contain private information about future economic activities and asset prices. Strong steepening trades are associated with negative payroll surprises in subsequent months and can predict asset markets' reaction to future payroll releases, suggesting that speculators hold superior information about future payrolls. Steepening trades can also predict the rise of stock prices within a few hours before subsequent FOMC announcements, implying that the pre-FOMC stock drift is driven by informed speculation. Overall, evidence highlights spread traders' superior information and its important role in explaining announcement returns and pre-announcement drifts. |
| Keywords: | Informed trading ; Term structure ; Business cycle ; Pre-FOMC ; Macroeconomic announcements |
| JEL: | E32 E43 G12 G14 |
| Date: | 2019–04–12 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2019-25&r=all |
| By: | Hieu Quang Nguyen; Abdul Hasib Rahimyar; Xiaodi Wang |
| Abstract: | The task of predicting future stock values has always been one that is heavily desired albeit very difficult. This difficulty arises from stocks with non-stationary behavior, and without any explicit form. Hence, predictions are best made through analysis of financial stock data. To handle big data sets, current convention involves the use of the Moving Average. However, by utilizing the Wavelet Transform in place of the Moving Average to denoise stock signals, financial data can be smoothened and more accurately broken down. This newly transformed, denoised, and more stable stock data can be followed up by non-parametric statistical methods, such as Support Vector Regression (SVR) and Recurrent Neural Network (RNN) based Long Short-Term Memory (LSTM) networks to predict future stock prices. Through the implementation of these methods, one is left with a more accurate stock forecast, and in turn, increased profits. |
| Date: | 2019–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1904.08459&r=all |
| By: | Rohan Arora; Guillaume Bédard-Pagé; Guillaume Ouellet Leblanc; Ryan Shotlander |
| Abstract: | This report provides a detailed technical description of a stress test model for investment funds called Ceto. The model quantifies how asset sales from investment funds could amplify a sudden decline in asset prices through the liquidity risk premium of the corporate bond market. Ceto is grounded in the literature on agents’ incentives and behaviour: it considers the response of investors to fund performance and the liquidity-management decisions of portfolio managers to meet demands for redemptions. The model also explicitly accounts for the provision of liquidity by broker-dealers and other potential buy-side investors. By accounting for the behaviour of different types of market participants, our approach allows us to account for the rich institutional features of, and heterogeneity within, the Canadian corporate bond market. The model can accommodate a range of different risk scenarios. |
| Keywords: | Economic models; Financial Institutions; Financial markets; Financial stability |
| JEL: | G12 G14 G20 G23 |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocatr:115&r=all |
| By: | Rohan Arora; Guillaume Bédard-Pagé; Guillaume Ouellet Leblanc; Ryan Shotlander |
| Abstract: | We create a hypothetical scenario to study the role bond funds play in intensifying shocks to the financial system. Using data from 2018 and 2007, we find that bond funds play a larger role now than they did in the past. |
| Keywords: | Financial markets; Financial stability |
| JEL: | G1 G20 G23 |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocsan:19-9&r=all |
| By: | Meyer, Josefin (Kiel Institute for the World Economy); Reinhart, Carmen M. (Harvard Kennedy School); Trebesch, Christoph (Kiel Institute for the World Economy) |
| 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%. |
| JEL: | F30 F34 G12 G15 N10 N20 |
| Date: | 2019–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:harjfk:rwp19-009&r=all |