nep-fmk New Economics Papers
on Financial Markets
Issue of 2019‒06‒24
fifteen papers chosen by

  1. The Keys of Predictability: A Comprehensive Study By Giovanni Barone-Adesi; Antonietta Mira; Matteo Pisati
  2. Dynamics and heterogeneity of subjective stock market expectations By Florian Heiss; Michael Hurd; Maarten van Rooij; Tobias Rossmann; Joachim Winter
  3. Time-Varying Exchange Rate Risk Premium By D.M.Nguyen, Anh; Dai Hung, Ly
  4. On the Nature of Jump Risk Premia By Piotr Orłowski; Paul Schneider; Fabio Trojani
  5. What Do Insiders Know? Evidence from Insider Trading Around Share Repurchases and SEOs By Peter Cziraki; Evgeny Lyandres; Roni Michaely
  6. Do Index Funds Monitor? By Davidson Heath; Daniele Macciocchi; Roni Michaely; Matthew Ringgenberg
  7. Repo Rates and the Collateral Spread Puzzle By Kjell G. Nyborg
  8. Trade Uncertainties and the Hedging Abilities of Bitcoin By Elie Bouri; Konstantinos Gkillas; Rangan Gupta
  9. Credit Default Swap Regulation in Experimental Bond Markets By Matthias Weber; John Duffy; Arthur Schram
  10. Private information and client connections in government bond markets By Kondor, Peter; Pinter, Gabor
  11. ESG Investing: From Sin Stocks to Smart Beta By Fabio Alessandrini; Eric Jondeau
  12. From Basel I to Basel III: Sequencing Implementation in Developing Economies By Caio Ferreira; Nigel Jenkinson; Christopher Wilson
  13. Basel III in Africa: Making It Work By Ozili, Peterson K
  14. Crude Awakening: Oil Prices and Bond Returns By Eric Jondeau; Qunzi Zhang; Xiaoneng Zhu
  15. Stress testing the German mortgage market By Barasinska, Nataliya; Haenle, Philipp; Koban, Anne; Schmidt, Alexander

  1. By: Giovanni Barone-Adesi (University of Lugano; Swiss Finance Institute); Antonietta Mira (Università della Svizzera italiana - InterDisciplinary Institute of Data Science); Matteo Pisati (Universita' della Svizzera Italiana)
    Abstract: The problem of market predictability can be decomposed into two parts: predictive models and predictors. At first, we show how the joint employment of model selection and machine learning models can dramatically increase our capability to forecast the equity premium out-of-sample. Secondly, we introduce batteries of powerful predictors which brings the monthly S&P500 R-square to a high level of 24%. Finally, we prove how predictability is a generalized characteristic of U.S. equity markets. For each of the three parts, we consider potential and challenges posed by the new approaches in the asset pricing field.
    Keywords: Markets Predictability, Machine Learning, Model Selection
    Date: 2019–03
  2. By: Florian Heiss; Michael Hurd; Maarten van Rooij; Tobias Rossmann; Joachim Winter
    Abstract: Between 2004 and 2016, we elicited individuals' subjective expectations of stock market returns in a Dutch internet panel at bi-annual intervals. In this paper, we develop a panel data model with a finite mixture of expectation types who differ in how they use past stock market returns to form current stock market expectations. The model allows. For rounding in the probabilistic responses and for observed and unobserved heterogeneity at several levels. We estimate the type distribution in the population and find evidence for considerable heterogeneity in expectation types and meaningful variation over time, in particular during the financial crisis of 2008/09.
    Keywords: expectations; stock markets; financial crisis; mixture models; surveys
    JEL: D12 D84 G11
    Date: 2019–06
  3. By: D.M.Nguyen, Anh; Dai Hung, Ly
    Abstract: We characterize the exchange rate risk premium on the context of a small open economy with controlled floating exchange rate regime. The data set includes 100 observations on case of Vietnam over 01/2011-04/2019. The risk premium is varying over time. And it is determined by output growth rate, inflation rate, foreign capital inflows and liquidity supply. As one application, the existence of time varying risk premium reduces the effectiveness of foreign exchange market intervention by forward contract.
    Keywords: Exchange Rate Premium, Foreign Exchange Intervention, Forward Contract
    JEL: F15 F36 F43
    Date: 2019–06
  4. By: Piotr Orłowski (HEC Montreal); Paul Schneider (University of Lugano - Institute of Finance; Swiss Finance Institute); Fabio Trojani (Swiss Finance Institute; University of Geneva)
    Abstract: We shed light on the nature of jump risk compensation by studying the profits from a trading strategy that bets on the high-frequency jump skew of S&P 500 returns. Earlier evidence suggests the jump risk premium is large and positive. We find it to be concentrated in periods when the index option market is closed, and investors cannot trade options. Whenever jump skew can be traded continuously, the premium vanishes. We conclude the jump skew premium in index options is not compensation for the risk of occasional, large returns, but for the investors’ inability to adjust their nonlinear risk exposure.
    Keywords: rare events, jump risk premium, options, high-frequency data
    JEL: G10 G12 C58
    Date: 2019–06
  5. By: Peter Cziraki (University of Toronto - Department of Economics; Tilburg Law and Economics Center (TILEC)); Evgeny Lyandres (Boston University); Roni Michaely (University of Geneva - Geneva Finance Research Institute (GFRI); Swiss Finance Institute)
    Abstract: We examine the nature of information contained in insider trades prior to corporate events. Insiders’ net buying increases before open market share repurchase announcements and decreases before SEOs. Higher insider net buying is associated with better post-event operating performance, a reduction in undervaluation, and, for repurchases, lower post-event cost of capital. Insider trading predicts announcement returns and, for repurchases, the long-term drift following events. Overall, our results suggest that insider trades before corporate events contain information about changes both in fundamentals and in investor sentiment. Information about fundamentals is incorporated slowly into prices, while information about mispricing is incorporated faster.
    Keywords: Insider Trading, Repurchases, Seasoned Equity Offers, Market Efficiency
    JEL: G14 G30 G32 G35
    Date: 2019–03
  6. By: Davidson Heath (University of Utah David Eccles School of Business); Daniele Macciocchi (University of Utah - David Eccles School of Business); Roni Michaely (University of Geneva - Geneva Finance Research Institute (GFRI); Swiss Finance Institute); Matthew Ringgenberg (University of Utah - Department of Finance)
    Abstract: We examine whether the rise of index investing leads to increased agency conflicts. Using a new research design that generates exogenous variation in fund holdings, we find that index funds are weak monitors. Unlike active funds, index funds rarely vote against firm management on corporate governance issues. Moreover, although index funds do exit 16% of their holdings each year, they do not use exit to enforce good governance. They also rarely file a Schedule 13D, indicating they do not intend to affect firm policies. Our results show the rise of index investing is shifting control from investors to corporate managers.
    Keywords: governance, index investing, monitoring, passive investing, voting, exit
    JEL: G12 G14
    Date: 2019–05
  7. By: Kjell G. Nyborg (University of Zurich - Department of Banking and Finance; Centre for Economic Policy Research (CEPR); Swiss Finance Institute)
    Abstract: Repo rates frequently exceed unsecured rates in practice. As an explanation, this paper derives a constrained-arbitrage relation between the unsecured rate, the repo rate, and the illiquidity adjusted expected rate of return of the underlying collateral. The theory is based on unsecured borrowing constraints in the market for liquidity. Repos and security cash-market trades are alternative means to get liquidity. Collateral spreads (unsecured less repo rate) can turn negative if borrowing constraints tighten, unsecured rates spike down, or from a depressed and illiquid security market. The constrained-arbitrage theory sheds light on the evolution of collateral spreads over time.
    Keywords: collateral spread, constrained-arbitrage, liquidity, market linkages, repo rate, unsecured rate, general collateral
    JEL: G01 G12 G21
    Date: 2019–02
  8. By: Elie Bouri (USEK Business School, Holy Spirit University of Kaslik, Jounieh, Lebanon); Konstantinos Gkillas (Department of Business Administration, University of Patras − University Campus, Rio, P.O. Box 1391, 26500 Patras, Greece); Rangan Gupta (Department of Economics, University of Pretoria, Pretoria, South Africa)
    Abstract: In this paper, we use daily data from October 2011 to May 2019 to estimate the monthly realized correlation between stock returns of the United States (US) and Bitcoin returns. Then, we relate the realized correlation with a news-based measure of the growth of trade uncertainty for the US. Our results show that the realized correlation is negatively impacted by increases in trade uncertainty, suggesting that Bitcoin can act as a hedge relative to the US stock market in the wake of heightened trade policy-related uncertainties, and can provide diversification benefits for investors.
    Keywords: US stock market, Bitcoin, realized correlation, trade uncertainty
    JEL: C22 G10
    Date: 2019–06
  9. By: Matthias Weber (University of St. Gallen); John Duffy (UC Irvine); Arthur Schram (University of Amsterdam)
    Abstract: Credit default swaps (CDS) played an important role in the financial crisis of 2008. While CDS can be used to hedge risks, they can also be used for speculative purposes (as occurred during the financial crisis) and regulations have been proposed to limit such speculative use. Here, we provide the first controlled experiment analyzing the pricing of credit default swaps in a bond market subject to default risk. We further use the laboratory as a testbed to analyze CDS regulation. Our results show that the regulation achieves the goal of increasing the use of CDS for hedging purposes while reducing the use of CDS for speculation. This success does not come at the expense of lower bond IPO revenues and does not negatively affect CDS prices or bond prices in the secondary market.
    Keywords: Experimental finance, asset market experiment, CDS, financial regulation, behavioral finance
    JEL: D53 C92
    Date: 2019–06–10
  10. By: Kondor, Peter; Pinter, Gabor
    Abstract: In government bond markets the number of dealers with whom clients trade changes through time. Our paper shows that this time-variation in clients’ connections serves as a proxy for time-variation in private information. Using proprietary data covering close to all dealer-client transactions in the UK government bond market, we show that clients have systematically better performance when trading with more dealers, and this effect is stronger during macroeconomic announcements. Most of the effect comes from clients’ increased ability to predict future yield changes (anticipation component) rather than these clients facing tighter bid-ask spreads (transaction component). To explore the nature of this private information, we find that clients with increased dealer connections can better predict the fraction of the aggregate order flow that is intermediated by dealers they regularly trade with. Positive trading performance is concentrated in those periods when clients have more dealer connections than usual.
    Keywords: Government Bond Market; Private Information; Client-Dealer Connections
    JEL: G12 G14 G24
    Date: 2019–01–02
  11. By: Fabio Alessandrini (University of Lausanne; Banque Cantonale Vaudoise); Eric Jondeau (University of Lausanne - Faculty of Business and Economics (HEC Lausanne); Swiss Finance Institute)
    Abstract: Research on socially responsible investment in equity markets initially focused on sin stocks. Since then, the availability of data has been extended substantially and now covers environmental, social, and governance (ESG) criteria. Using ESG scores of firms belonging to the MSCI World universe, we measure the impact of score-based exclusion on both passive investment and smart beta strategies. We find that exclusion leads to improved scores of otherwise standard portfolios without deterioration of their risk-adjusted performance. Smart beta strategies exhibit a similar pattern, often in a more pronounced way. Moreover, our results demonstrate that exclusion also implies regional and sectoral tilts as well as (possibly undesirable) risk exposures of the portfolios.
    Date: 2019–03
  12. By: Caio Ferreira; Nigel Jenkinson; Christopher Wilson
    Abstract: Developing economies can strengthen their financial systems by implementing the main elements of global regulatory reform. But to build an effective prudential framework, they may need to adapt international standards taking into account the sophistication and size of their financial institutions, the relevance of different financial operations in their market, the granularity of information available and the capacity of their supervisors. Under a proportionate application of the Basel standards, smaller institutions with less complex business models would be subject to a simpler regulatory framework that enhances the resilience of the financial sector without generating disproportionate compliance costs. This paper provides guidance on how non-Basel Committee member countries could incorporate banks’ capital and liquidity standards into their framework. It builds on the experience gained by the authors in the course of their work in providing technical assistance on—and assessing compliance with—international standards in banking supervision.
    Date: 2019–06–14
  13. By: Ozili, Peterson K
    Abstract: Basel III is a framework to protect the global banking system. This article provides a policy discussion on Basel III in Africa. The significance of Basel III is discussed, and some ideas to consider when implementing Basel III to make it work in Africa, are provided. Under Basel III, the African banking industry should expect better capital quality, higher capital levels, minimum liquidity requirement for banks, reduced systemic risk, and differences in Basel III transitional arrangements. This article also emphasizes that (i) there should be enough time for the transition to Basel III in Africa, (ii) a combination of micro and macro-prudential regulations is needed; and (iii) the need to repair the balance sheets of banks, in preparation for Basel III. The discussions in this article will benefit policymakers, academics and other stakeholders interested in financial regulation in Africa such as the World bank and the International Monetary Fund (IMF).
    Keywords: Basel III, Bank business models, Bank performance, Financial stability, Capital regulation, Bank regulation, Africa
    JEL: G21 G23 G28 G32
    Date: 2019
  14. By: Eric Jondeau (University of Lausanne - Faculty of Business and Economics (HEC Lausanne); Swiss Finance Institute); Qunzi Zhang (Shandong University); Xiaoneng Zhu (Shanghai University of Finance and Economics)
    Abstract: Oil price changes fail to predict asset returns because they are too noisy. We construct an oil trend factor that fi lters out noise and provide evidence that it predicts bond risk premiums well. This result holds in developed and emerging markets, both in sample and out of sample. Notably, the oil trend factor improves predictions based on current term structure predictors, such as the first three principal components of yields and the Cochrane and Piazzesi (2005) factor. A puzzle emerging from our results is that oil price increases, which are generally thought to precede economic recessions, are in fact associated with subsequent lower bond returns. To solve this puzzle, we demonstrate that not all oil price shocks are alike: Although oil demand and supply shocks have opposite implications for economic activity and bond risk premiums, the oil trend factor is mainly related to demand shocks. Therefore, increases in the oil trend tend to signal a strong economy and lower bond returns.
    Keywords: bond risk premium, demand shocks, oil prices, return predictability
    JEL: G11 G12 G15 P36
    Date: 2019–04
  15. By: Barasinska, Nataliya; Haenle, Philipp; Koban, Anne; Schmidt, Alexander
    Abstract: This paper presents a framework for estimating losses in the residential real estate mortgage portfolios of German banks. We develop an EL model where LGD estimates are based on current collateral values and PD dynamics are estimated using a structural PVAR approach. We confirm empirically that foreclosure rates are rising with the unemployment rate and are inversely related to house price inflation. Being consistent with our expectation that strategic defaults do not play a central role given the full personal liability of German households, the results give broad support for the double-trigger hypothesis of mortgage defaults. In order to analyse the possible credit losses stemming from residential mortgage lending we then use the model to run a top-down stress test and simulate losses on the individual bank level for the years from 2018 to 2020 for the whole German banking sector. Our results show that loss rates in the residential mortgage portfolios of German banks do increase significantly in an adverse economic environment. The estimated expected losses are widely distributed in the banking system leading, on average, to a 0.4 percentage points reduction in the CET1 ratio over the simulation period.
    Keywords: residential real estate,mortgages,credit risk,stress testing,German banks
    JEL: G01 G17 G21 G28
    Date: 2019

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