nep-fmk New Economics Papers
on Financial Markets
Issue of 2019‒08‒26
nine papers chosen by

  1. The implied Sharpe ratio By Ankush Agarwal; Matthew Lorig
  2. Correlation Risk, Strings and Asset Prices By Distaso, Walter; Mele, Antonio; Vilkov, Grigory
  3. Horizontal industry relationships and return predictability By Schlag, Christian; Zeng, Kailin
  4. Random walk model from the point of view of algorithmic trading By Oleh Danyliv; Bruce Bland; Alexandre Argenson
  5. Forecast Encompassing Tests for the Expected Shortfall By Timo Dimitriadis; Julie Schnaitmann
  6. The Wall Street Stampede: Exit as Governance with Interacting Blockholders By Cvijanovic, Dragana; Dasgupta, Amil; Zachariadis, Konstantinos
  7. Taxable Stock Trading with Deep Reinforcement Learning By Shan Huang
  8. How Impactful is Telecom Efficiency to Company Stock Value? By Riko Hendrawan
  9. British Stock Market, BREXIT and Media Sentiments - A Big Data Analysis By Gopal K. Basak; Pranab Kumar Das; Sugata Marjit; Debashis Mukherjee; Lei Yang

  1. By: Ankush Agarwal; Matthew Lorig
    Abstract: In an incomplete market, including liquidly-traded European options in an investment portfolio could potentially improve the expected terminal utility for a risk-averse investor. However, unlike the Sharpe ratio, which provides a concise measure of the relative investment attractiveness of different underlying risky assets, there is no such measure available to help investors choose among the different European options. We introduce a new concept -- the implied Sharpe ratio -- which allows investors to make such a comparison in an incomplete financial market. Specifically, when comparing various European options, it is the option with the highest implied Sharpe ratio that, if included in an investor's portfolio, will improve his expected utility the most. Through the method of Taylor series expansion of the state-dependent coefficients in a nonlinear partial differential equation, we also establish the behaviour of the implied Sharpe ratio with respect to an investor's risk-aversion parameter. In a series of numerical studies, we compare the investment attractiveness of different European options by studying their implied Sharpe ratio.
    Date: 2019–08
  2. By: Distaso, Walter; Mele, Antonio; Vilkov, Grigory
    Abstract: Standard asset pricing theories treat return volatility and correlations as two intimately related quantities, which hinders achieving a neat definition of a correlation premium. We introduce a model with a continuum of securities that have returns driven by a string. This model leads to new arbitrage pricing restrictions, according to which, holding any asset requires compensation for the granular exposure of this asset returns to changes in all other asset returns: an average correlation premium. We find that this correlation premium is both statistically and economically significant, and considerably fluctuates, driven by time-varying correlations and global market developments. The model explains the cross-section of expected returns and their counter-cyclicality without making reference to common factors affecting asset returns. It also explains the time-series behavior of the premium for the risk of changes in asset correlations (the correlation-risk premium), including its inverse relation with realized correlations.
    Keywords: arbitrage pricing; correlation premium; correlation-risk premium; cross-section of returns; implied correlation; string models
    JEL: G11 G12 G13 G17
    Date: 2019–07
  3. By: Schlag, Christian; Zeng, Kailin
    Abstract: It has been documented that vertical customer-supplier links between industries are the basis for strong cross-sectional stock return predictability (Menzly and Ozbas (2010)).We show that robust predictability also arises from horizontal links between industries, i.e., from the fact that industries are competitors or offer products, which are substitutes for each other. These horizontally linked industries exhibit positively correlated fundamentals. The signal derived from this type of connectedness is the basis for significant alpha in sorted portfolio strategies, and informed investors take the related information into account when they form their portfolios. We thus provide evidence of return predictability based on a new type of economic links between industries not captured in previous studies.
    Keywords: connected industries,information flow,return predictability
    JEL: G12 E44 D81
    Date: 2019
  4. By: Oleh Danyliv; Bruce Bland; Alexandre Argenson
    Abstract: Despite the fact that an intraday market price distribution is not normal, the random walk model of price behaviour is as important for the understanding of basic principles of the market as the pendulum model is a starting point of many fundamental theories in physics. This model is a good zero order approximation for liquid fast moving markets where the queue position is less important than the price action. In this paper we present an exact solution for the cost of the static passive slice execution. It is shown, that if a price has a random walk behaviour, there is no optimal limit level for an order execution: all levels have the same execution cost as an immediate aggressive execution at the beginning of the slice. Additionally the estimations for the risk of a limit order as well as the probability of a limit order execution as functions of the slice time and standard deviation of the price are derived.
    Date: 2019–08
  5. By: Timo Dimitriadis; Julie Schnaitmann
    Abstract: In this paper, we introduce new forecast encompassing tests for the risk measure Expected Shortfall (ES). Forecasting and forecast evaluation techniques for the ES are rapidly gaining attention through the recently introduced Basel III Accords, which stipulate the use of the ES as primary market risk measure for the international banking regulations. Encompassing tests generally rely on the existence of strictly consistent loss functions for the functionals under consideration, which do not exist for the ES. However, our encompassing tests are based on recently introduced loss functions and an associated regression framework which considers the ES jointly with the corresponding Value at Risk (VaR). This setup facilitates several testing specifications which allow for both, joint tests for the ES and VaR and stand-alone tests for the ES. We present asymptotic theory for our encompassing tests and verify their finite sample properties through various simulation setups. In an empirical application, we utilize the encompassing tests in order to demonstrate the superiority of forecast combination methods for the ES for the IBM stock.
    Date: 2019–08
  6. By: Cvijanovic, Dragana; Dasgupta, Amil; Zachariadis, Konstantinos
    Abstract: In firms with multiple blockholders governance via exit is affected by how blockholders react to each others' exit. Institutional investors, who hold the majority of equity blocks, are heterogeneous in their incentives. How do these incentives affect the manner in which institutional blockholders respond to each others' exit? We present a model that shows that open-ended institutional investors, who are subject to investor redemption risk, will be sensitive to an informed blockholder's exit, giving rise to correlated exits and strengthening governance. Thus, exposure to redemption risk, universally a negative force in asset pricing, plays a positive role in corporate governance. Using data on engagement campaigns by activist hedge funds we present large-sample evidence consistent with our theoretical mechanism.
    Keywords: corporate governance; exit; Herding; institutional investors
    Date: 2019–07
  7. By: Shan Huang
    Abstract: In this paper, we propose stock trading based on the average tax basis. Recall that when selling stocks, capital gain should be taxed while capital loss can earn certain tax rebate. We learn the optimal trading strategies with and without considering taxes by reinforcement learning. The result shows that tax ignorance could induce more than 62% loss on the average portfolio returns, implying that taxes should be embedded in the environment of continuous stock trading on AI platforms.
    Date: 2019–07
  8. By: Riko Hendrawan (Faculty Economic and Business, Telkom University, Indonesia Author-2-Name: Kristian WA Nugroho Author-2-Workplace-Name: Faculty Economic and Business, Telkom University, Indonesia Author-3-Name: Gayuh T Permana Author-3-Workplace-Name: Faculty Economic and Business, Telkom University, Indonesia Author-4-Name: Author-4-Workplace-Name: Author-5-Name: Author-5-Workplace-Name: Author-6-Name: Author-6-Workplace-Name: Author-7-Name: Author-7-Workplace-Name: Author-8-Name: Author-8-Workplace-Name:)
    Abstract: Objective - The telecom industry is one of the optimistic industries that is still growing. In South East Asia, between 2008-2017, the number of subscribers increased 10.07% annually, and revenue for the industry grew 6.08% annually. However, Net Profit Margin, EBITDA, and EBIT value during the same period declined at the time revenue amount was increasing. One of the visible health factors and part of the valuation factor is stock value. Hence the research question of this study is: What is the impact and significance of telecom operators' efficiency to stock value? Methodology/Technique - In this study, efficiency will be measured and analyzed using Stochastic Frontier Approach (SFA) method. By using same method, the impact of efficiency to stock value will be measured, as well as the significance level. Finding - The results of this research show that from 14 telecom operators observed, TLKM (Indonesia) obtained the highest efficiency score (0.984) whereas StarHub (Malaysia) had the lowest efficiency score (0.405). TLKM (Indonesia) and AIS (Thailand) had a similar efficiency score given the fact that the behaviour of the subscribers is similar and they have the same country characteristic. Novelty - All of the input and output variables have a positive impact on the efficiency parameter except Total Asset which has negative impact on the efficiency score. By using further analysis of the t-Ratio between the variables and efficiency, it can be seen that stock value is impacted by the efficiency parameters but this impact is not significant (t-Ratio 1.35). Type of Paper - Empirical.
    Keywords: Efficiency; Telecom Operators; Stock Value, Indonesia.
    JEL: G14 G32 G39
    Date: 2019–07–11
  9. By: Gopal K. Basak; Pranab Kumar Das; Sugata Marjit; Debashis Mukherjee; Lei Yang
    Abstract: In this paper we show, using a Machine Learning Framework and utilising a substantial corpus of media articles on Brexit, confirmed evidence of co-integration and causality between the ensuing media sentiments and British currency. The novel contribution of this paper is that along with sentiment analysis using commonly used lexicons, we devised a method using Bayesian learning to create a more context aware and more informative lexicon for Brexit. Moreover, leveraging and extending this we can unearth hidden relationship between originating media sentiments and related economic and financial variables. Our method is a distinct improvement over the existing ones and can predict out of sample outcomes better than conventional ones.
    Keywords: digitization, machine learning
    Date: 2019

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