nep-fmk New Economics Papers
on Financial Markets
Issue of 2019‒09‒23
nine papers chosen by

  1. Jensen's alpha measured and decomposed under skew symmetric semi-parametric model for error terms in the market model By Navruzbek Karamatov; Ryozo Miura
  2. A Deep Learning Framework for Pricing Financial Instruments By Qiong Wu; Zheng Zhang; Andrea Pizzoferrato; Mihai Cucuringu; Zhenming Liu
  3. The Risks of Safe Assets By Yang Liu; Amir Yaron; Lukas Schmid
  4. Public attention to environmental issues and stock market returns By Imane El Ouadghiri; Khaled Guesmi; Jonathan Peillex; Andreas Ziegler
  5. The Agency of CoCos: Why Contingent Convertible Bonds Aren't for Everyone By Roman Goncharenko; Steven Ongena; Asad Rauf
  6. An analysis of asset pricing models using out of sample data from the NYSE: 1900-1925 By Miguel Cantillo Simon; Nick Wonder
  7. Dancing With Activists By Lucian A. Bebchuk; Alon Brav; Wei Jiang; Thomas Keusch
  8. World financial cycles By Yan Bai; Fabrizio Perri; Patrick Kehoe
  9. Underpricing in seasoned equity offerings: Evidence from European REITs and REOCs By Felix Lorenz

  1. By: Navruzbek Karamatov; Ryozo Miura
    Abstract: A simple estimation method, namely the Ordinary Least Squares (LS) is applied for nearly all empirical analysis to estimate ƒÀ. However, Jensen (1968) made clear that CAPM is not able to explain abnormal returns and is used to account for this unobserved factors. More importantly Jensen's Alpha is obtained as a mean value of residuals from a simple regression. Nonetheless, LS is sensitive to outliers and this could make estimators to be vulnerable. As empirical studies states, observed residuals are not symmetrically distributed. Can asymmetry in error term distribution explain Jensen's Alpha? This research tries to find the answer by applying robust Rank statistics, in comparison with Least Squares, to fit a simple linear regression into Nikkei 225, FTSE 100 and S&P 500 stocks. Furthermore, the Generalized Lehmann's Alternative Model (GLAM) is applied to observed residuals to analyze the location and asymmetry of the residuals distribution. We found that residuals are, indeed, noticeably skewed. GLAM model shows that ma- jority of stocks in all three markets experience asymmetry, especially during the financially stressful periods in 2008. In addition, our asymmetry parameter ƒÆ possesses a statistically significant relation to ƒ¿ and to the skew effect which is defined as a difference between ƒ¿ and location (ƒÊ). Furthermore, in order to obtain the underlying F distribution we fitted t distribution with varying degrees of freedom. Our results show that most of the stocks experience smaller degrees of freedom meaning that R estimate is more effcient than its counterpart LS. Moreover we found that R approach is suitable even in the case of high degrees of freedom (close to normal) but large ƒÆ values. Next, we also found that LS underestimates ƒ¿ and ƒÀ for majority of stocks with smaller degrees of freedom.
    Date: 2019–07
  2. By: Qiong Wu; Zheng Zhang; Andrea Pizzoferrato; Mihai Cucuringu; Zhenming Liu
    Abstract: We propose an integrated deep learning architecture for the stock movement prediction. Our architecture simultaneously leverages all available alpha sources. The sources include technical signals, financial news signals, and cross-sectional signals. Our architecture possesses three main properties. First, our architecture eludes overfitting issues. Although we consume a large number of technical signals but has better generalization properties than linear models. Second, our model effectively captures the interactions between signals from different categories. Third, our architecture has low computation cost. We design a graph-based component that extracts cross-sectional interactions which circumvents usage of SVD that's needed in standard models. Experimental results on the real-world stock market show that our approach outperforms the existing baselines. Meanwhile, the results from different trading simulators demonstrate that we can effectively monetize the signals.
    Date: 2019–09
  3. By: Yang Liu (University of Hong Kong); Amir Yaron (Wharton-University of Pennsylvania); Lukas Schmid (Duke University)
    Abstract: US government bonds exhibit many characteristics often attributed to safe assets: They are very liquid and lenders readily accept them as collateral. Indeed, a growing literature documents significant convenience yields, perhaps due to liquidity, in scarce US Treasuries, suggesting that rising Treasury supply and government debt comes with a declining liquidity premium and a fall in firms' relative cost of debt financing. In this paper, we empirically document a dual role for government debt. Through a liquidity channel, an increase in government debt improves liquidity and lowers liquidity premia by facilitating debt rollover, thereby reducing credit spreads. Through an uncertainty channel, however, rising government debt creates policy uncertainty, raising credit spreads and default risk premia. We interpret and quantitatively evaluate these two channels through the lens of a general equilibrium asset pricing model with risk-sensitive agents subject to liquidity shocks, in which firms issue defaultable bonds and the government issues tax-financed bonds that endogenously enjoy liquidity benefits. The calibrated model generates quantitatively realistic liquidity spreads and default risk premia, in line with historical US debt policies and low corporate default rates. Quantitatively, our model suggests that while rising government debt reduces liquidity spreads, it not only crowds out corporate debt financing, and therefore, investment, but also creates uncertainty reflected in endogenous tax volatility, credit spreads, and risk premia, and ultimately consumption volatility. Therefore, increasing safe asset supply can be risky.
    Date: 2019
  4. By: Imane El Ouadghiri (Pole Universitaire Leonard de Vinci, Research Center); Khaled Guesmi (Paris School of Business); Jonathan Peillex (Pole Universitaire Leonard de Vinci, Research Center); Andreas Ziegler (University of Kassel)
    Abstract: This paper empirically examines the effect of public attention to climate change and pollution on the weekly returns on US sustainability stock indices (i.e. the DJSI US and the FTSE4Good USA Index) in comparison to their conventional counterparts (i.e. the S&P 500 Index and the FTSE USA). In addition to unexpected global climate-related natural weather disasters, we consider two complementary measures of public attention to these environmental issues: (i) US media attention to climate change and pollution and (ii) the US Google Search Volume Index for these two keywords. Robust to several sensitivity analyses, our econometric analysis for the period from 2004 to 2018 reveals that public attention to environmental issues has a significantly positive (negative) effect on the returns on US sustainability (conventional) stock indices. A possible explanation of this result is that high public attention to environmental issues may drive traditionally sustainable investors, neo-sustainable, and opportunistic self-interested investors to favor stocks of sustainable firms. The insights from our empirical study are important for private and institutional investors, managers of firms, and public policy.
    Keywords: Public attention, environmental issues, stock returns, sustainability stock indices, asset pricing models
    JEL: Q51 G14 Q53 Q54
    Date: 2019
  5. By: Roman Goncharenko (KU Leuven - Department of Accountancy, Finance and Insurance (AFI)); Steven Ongena (University of Zurich - Department of Banking and Finance; Swiss Finance Institute; KU Leuven; Centre for Economic Policy Research (CEPR)); Asad Rauf (KUniversity of Groningen)
    Abstract: Most regulators grant contingent convertible bonds (CoCos) the status of equity. Theory, however, suggests that CoCos can induce debt overhang, thereby, increasing the cost of issuing equity. First, we theoretically investigate how the extent of this debt overhang varies with bank characteristics. Our model predicts that riskier banks face higher debt overhang from CoCos. Our empirical analysis confirms that riskier banks are less likely to issue CoCos than their safer counterparts. Since under Basel III banks are expected to raise equity prior to CoCo conversion, riskier banks that anticipate future equity issuance are less likely to issue CoCos before.
    Keywords: CoCos, Contingent Convertible Bonds, Bank Capital Structure, Debt Overhang, Basel III
    JEL: G01 G12 G24
    Date: 2019–06
  6. By: Miguel Cantillo Simon (Universidad de Costa Rica); Nick Wonder (University of Wyoming)
    Abstract: This paper uses financial data from 1900 to 1925 to run out of sample tests of different asset pricing models. We find that we cannot reject the strong predictions of Sharpe’s (1964) CAPM, but that there are portfolios with significant alphas that violate Sharpe’s CAPM weak predictions. The Black (1972) version of the CAPM performs worse than Sharpe’s counterpart. We also test the Fama French Carhart framework, and find that only the market and size factors work as with modern data. The value factor is statistically insignificant, and the momentum factor, while significant, has the opposite sign of the modern momentum factor.
    Date: 2019–07
  7. By: Lucian A. Bebchuk; Alon Brav; Wei Jiang; Thomas Keusch
    Abstract: An important milestone often reached in the life of an activist engagement is entering into a “settlement” agreement between the activist and the target’s board. Using a comprehensive hand-collected data set, we analyze the drivers, nature, and consequences of such settlement agreements. Settlements are more likely when the activist has a credible threat to win board seats in a proxy fight and when incumbents’ reputation concerns are stronger. Consistent with incomplete contracting, face-saving benefits and private information considerations, settlements commonly do not contract directly on operational or leadership changes sought by the activist but rather on board composition changes. Settlements are accompanied by positive stock price reactions, and they are subsequently followed by changes of the type sought by activists, including CEO turnover, higher shareholder payouts, and improved operating performance. We find no evidence to support concerns that settlements enable activists to extract rents at the expense of other investors. Our analysis provides a look into the “black box” of activist engagements and contributes to understanding how activism brings about changes in target companies.
    JEL: G12 G23 G32 G35 G38 K22
    Date: 2019–08
  8. By: Yan Bai (University of Rochester); Fabrizio Perri (Federal Reserve Bank of Minneapolis); Patrick Kehoe (Stanford University)
    Abstract: Data shows that, in the cross section of emerging countries, sovereign spreads are highly correlated, much more so than local economic conditions. However, in standard models of sovereign default the main drivers of sovereign spreads are local conditions. This paper proposes a mechanism that can explain, at the same time, the high correlation of spreads and the low correlation of local conditions. The model features a large developed economy, which lends to a large number of developing economies, using long run bonds that can be defaulted on. The key feature of the model is the presence of long run risk (as in Bansal and Yaron, 2005). We first show that the model can account for the dynamics of several real variables and of sovereign spreads in the cross section of developing economies. We then use the model for examining how much of the fluctuations in spreads in developing economies arise from the changes in long risk in the developed economy (the price of risk), v/s changes in long run risk in the developing economies themselves (the quantity of risk). We find that 2/3 of fluctuations in spreads are explained by the quantity of risk. Our conclusion is that world financial cycle is largely driven by a world-wide, low frequency long run risk component, rather than simply by fluctuations in the price of risk driven that shocks in developed countries that alter their willingness to lend.
    Date: 2019
  9. By: Felix Lorenz
    Abstract: Because real estate investment trusts (REITs) are limited in their funding due to restrictions on the debt ratio and retained earnings, seasoned equity offerings (SEOs) are major events in the lifetime of a REIT and essential to ensure profitable growth (Ghosh et al. 2000). To finance growth strategies, there is consensus in the literature that REITs need to regularly raise money through capital increases and therefore access the capital market more often. Although SEOs play an important role for REITs as well as for real estate operating companies (REOCs), issued shares are regularly offered at an offer price significantly lower than the price the shares are traded on the offer day – defined as underpricing. Consequently, the issuing firm accept multiples of their year’s earnings as “money left on the table” at equity offerings (Goodwin 2013).While underpricing is highly researched for initial public offerings (IPOs), far less is known about SEOs. Furthermore, literature on the pricing of seasoned offerings focuses on listed real estate in the US, with the European market remaining mainly unobserved. Because the overall market capitalization of REITs and the money raised through SEOs is rapidly growing in Europe with more and more countries implementing the REIT-regime, the objective of the study is to investigate underpricing in SEOs for European REITs and REOCs.Considering equity offerings, literature provides several theories for the occurrence of underpricing. Theories on asymmetric information and value uncertainty based on Rock’s “winner’s curse” (1986) and Beatty and Ritter (1986) were among the first. They conclude underpricing being attributed to cost-intensive information gathering processes due to value uncertainty around the offering. Further explanations contain theories on placement cost (Corwin 2003, Goodwin 2013) and timing of SEOs (Baker and Wurgler 2002, Andrikopoulos et al. 2017). This study contains offering, company specific and market data to gain further insights on the “underpricing puzzle” with respect to European firms. Total proceeds and market capitalization are applied as proxies for value uncertainty around the SEO. We use relative proceeds to check for hypothesis on placement cost. Additionally, information on the debt ratio control for liquidity issues. In terms of timing theories, performance indicators and stock price volatility are used. We furthermore investigate differences in underpricing for REITs and REOCs. Due to higher transparency, we suggest lower underpricing for REITs than for REOCs being in line with previous studies (Ascherl and Schaefers 2016). We expect also to draw conclusion on whether real estate companies with a specialized investment focus outperform diversified ones in terms of leaving less money “left on the table” (Freybote et al. 2008).This study is to our best knowledge the first to investigate underpricing in SEOs for European REITs and REOCs. We expect to identify determinants of underpricing for SEOs and analyze differences for REITs and REOCs. We furthermore suggest our findings to be lower than comparable studies on IPOs due to the disclosed track record after the IPO, but higher than comparable studies on SEOs in the US due to the maturity and market awareness of real estate companies, especially REITs, and the incremental conduction of equity offerings (e.g. ATM offerings). The goal of the study is to provide a better understanding of the underpricing phenomenon to contribute to the solution of the “underpricing puzzle”.
    Keywords: Initial returns; market timing; REITs and REOCs; seasoned equity offerings; Underpricing
    JEL: R3
    Date: 2019–01–01

General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.