nep-fmk New Economics Papers
on Financial Markets
Issue of 2019‒11‒11
eleven papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Sentimental Recovery By Altan Pazarbasi; Paul Schneider; Grigory Vilkov
  2. The Reactive Beta Model By Sebastien Valeyre; Denis S. Grebenkov; Sofiane Aboura
  3. A Rational Finance Explanation of the Stock Predictability Puzzle By Abootaleb Shirvani; Svetlozar T. Rachev; Frank J. Fabozzi
  4. Synergizing Ventures By Akcigit, Ufuk; Dinlersoz, Emin M.; Greenwood, Jeremy; Penciakova, Veronika
  5. Differential Treatment in the Bond Market: Sovereign Risk and Mutual Fund Portfolios By Nathan Converse; Enrico Mallucci
  6. Don’t Take Their Word For It: The Misclassification of Bond Mutual Funds By Huaizhi Chen; Lauren Cohen; Umit Gurun
  7. Stock market's assessment of monetary policy transmission: The cash flow effect By Gürkaynak, Refet S.; Karasoy-Can, Hatice Gökçe; Lee, Sang Seok
  8. An Improved Method to Predict Assignment of Stocks into Russell Indexes By Itzhak Ben-David; Francesco A. Franzoni; Rabih Moussawi
  9. Corporate Yields and Sovereign Yields By Bevilaqua, Julia; Hale, Galina; Tallman, Eric
  10. The Federal Funds Market over the 2007-09 Crisis By Copeland, Adam
  11. The Predictability of Real Estate Excess Returns: An Out-of-Sample Economic Value Analysis By Massimo Guidolin; Manuela Pedio; Milena Petrova

  1. By: Altan Pazarbasi (Frankfurt School of Finance & Management); Paul Schneider (University of Lugano - Institute of Finance; Swiss Finance Institute); Grigory Vilkov (Frankfurt School of Finance & Management)
    Abstract: We extract subjective risk-neutral and physical distributions from option quotes on S&P 500 and VIX futures according to agents’ sentiment. Without assumptions on preferences or underlying processes, we only impose a good-deal bound on the distributions to recover the bivariate distribution of the S&P 500 and VIX. We devise optimal Sharpe ratio trading strategies in S&P500 and VIX futures markets that are subjective to the agents, and implement them at the observed quotes. The bivariate distributions define important investment opportunities that would not be available considering the two markets separately. Dispersion of beliefs regarding both market and volatility dynamics is related to, and predicts macroeconomic indicators.
    Keywords: Recovery, sentiment, market views, volatility trading, market spanning
    JEL: G11 G12 G13 G17
    Date: 2019–10
  2. By: Sebastien Valeyre; Denis S. Grebenkov; Sofiane Aboura
    Abstract: We present a reactive beta model that includes the leverage effect to allow hedge fund managers to target a near-zero beta for market neutral strategies. For this purpose, we derive a metric of correlation with leverage effect to identify the relation between the market beta and volatility changes. An empirical test based on the most popular market neutral strategies is run from 2000 to 2015 with exhaustive data sets including 600 US stocks and 600 European stocks. Our findings confirm the ability of the reactive beta model to withdraw an important part of the bias from the beta estimation and from most popular market neutral strategies.
    Date: 2019–11
  3. By: Abootaleb Shirvani; Svetlozar T. Rachev; Frank J. Fabozzi
    Abstract: In this paper, we address one of the main puzzles in finance observed in the stock market by proponents of behavioral finance: the stock predictability puzzle. We offer a statistical model within the context of rational finance which can be used without relying on behavioral finance assumptions to model the predictability of stock returns. We incorporate the predictability of stock returns into the well-known Black-Scholes option pricing formula. Empirically, we analyze the option and spot trader's market predictability of stock prices by defining a forward-looking measure which we call "implied excess predictability". The empirical results indicate the effect of option trader's predictability of stock returns on the price of stock options is an increasing function of moneyness, while this effect is decreasing for spot traders. These empirical results indicate potential asymmetric predictability of stock prices by spot and option traders. We show in pricing options with the strike price significantly higher or lower than the stock price, the predictability of the underlying stock's return should be incorporated into the option pricing formula. In pricing options that have moneyness close to one, stock return predictability is not incorporated into the option pricing model because stock return predictability is the same for both types of traders. In other words, spot traders and option traders are equally informed about the future value of the stock market in this case. Comparing different volatility measures, we find that the difference between implied and realized variances or variance risk premium can potentially be used as a stock return predictor.
    Date: 2019–11
  4. By: Akcigit, Ufuk (University of Chicago); Dinlersoz, Emin M. (U.S. Census Bureau); Greenwood, Jeremy (University of Pennsylvania); Penciakova, Veronika (Federal Reserve Bank of Atlanta)
    Abstract: Venture capital (VC) and growth are examined both empirically and theoretically. Empirically, VC-backed startups have higher early growth rates and initial patent quality than non-VC-backed ones. VC backing increases a startup's likelihood of reaching the right tails of the firm size and innovation distributions. Furthermore, outcomes are better for startups matched with more experienced venture capitalists. An endogenous growth model, where venture capitalists provide both expertise and financing for business startups, is constructed to match these facts. The presence of venture capital, the degree of assortative matching between startups and financiers, and the taxation of VC-backed startups matter significantly for growth.
    Keywords: venture capital; assortative matching; endogenous growth; IPO; management; mergers and acquisitions; research and development; startups; synergies; taxation; patents
    JEL: E13 E22 G24 L26 O16 O31 O40
    Date: 2019–09–01
  5. By: Nathan Converse; Enrico Mallucci
    Abstract: How does sovereign risk affect investors' behavior? We answer this question using a novel database that combines sovereign default probabilities for 27 developed and emerging markets with monthly data on the portfolios of individual bond mutual funds. We first show that changes in yields do not fully compensate investors for additional sovereign risk, so that bond funds reduce their exposure to a country's assets when its sovereign default risk increases. However, the magnitude of the response varies widely across countries. Fund managers aggressively reduce their exposure to high-debt countries and high-risk countries. By contrast, they are more lenient toward core developed markets. In this sense, these economies appear to receive preferential treatment. Second, we document what determines the destination of reallocation ows. When fund managers reduce their exposure to a country in response to its sovereign risk, they shift their assets to countries outside the immediate geographic region while at the same time avoiding countries with high debt-to-GDP ratios and markets to which they are already heavily exposed. These results are supportive of models of sovereign default that assign a nontrivial role to the preferences of international creditors.
    Keywords: Sovereign risk ; Mutual funds ; International capital flows ; Spillovers
    JEL: F3 F32 F36 G1 G11 G15 G2 G23
    Date: 2019–10–18
  6. By: Huaizhi Chen; Lauren Cohen; Umit Gurun
    Abstract: We provide evidence that mutual fund managers misclassify their holdings, and that these misclassifications have a real and significant impact on investor capital flows. In particular, we provide the first systematic study of bond funds’ reported asset profiles to Morningstar against their actual portfolios. Many funds report more investment grade assets than are actually held in their portfolios, making these funds appear significantly less risky. This results in pervasive misclassifications across the universe of US fixed income mutual funds by Morningstar, who relies on these reported holdings. The problem is widespread- resulting in about 30% of funds being misclassified with safer profiles, when compared against their actual, publicly reported holdings. “Misclassified funds” – i.e., those that hold risky bonds, but claim to hold safer bonds– outperform the actual low-risk funds in their peer groups. “Misclassified funds” therefore receive higher Morningstar Ratings (significantly more Morningstar Stars) and higher investor flows due to this perceived outperformance. However, when we correctly classify them based on their actual risk, these funds are mediocre performers. Misreporting is stronger following several quarters of large negative returns, and it is strong at the fund family level. We report those families that have the highest percentage of misreported funds in the sample.
    JEL: G11 G12 G23 G24 K0
    Date: 2019–11
  7. By: Gürkaynak, Refet S.; Karasoy-Can, Hatice Gökçe; Lee, Sang Seok
    Abstract: We show that firm liability structure and associated cash flow matter for firm behavior, and that financial market participants price stocks accordingly. Looking at firm level stock price changes around monetary policy announcements, we find that firms that have more cash flow exposure see their stock prices affected more. The stock price reaction depends on the maturity and type of debt issued by the firm, and the forward guidance provided by the Fed. This effect has remained intact during the ZLB period. Importantly, we show that the effect is not a rule of thumb behavior outcome and that the marginal stock market participant actually studies and reacts to the liability structure of firm balance sheets. The cash flow exposure at the time of monetary policy actions predicts future net worth, investment, and assets, verifying the stock pricing decision and also providing evidence of cash flow effects on firms' real behavior. The results hold for S&P500 firms that are usually thought of not being subject to tight financial constraints.
    Keywords: cash flow effect of monetary policy,investor sophistication,financial frictions,stock pricing
    JEL: E43 E44 E52 E58 G14
    Date: 2019
  8. By: Itzhak Ben-David (Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER)); Francesco A. Franzoni (USI Lugano; Swiss Finance Institute; Centre for Economic Policy Research (CEPR)); Rabih Moussawi (Villanova University - Department of Finance; University of Pennsylvania - The Wharton School)
    Abstract: A growing literature uses the Russell 1000/2000 reconstitution event as an identification strategy to investigate corporate finance and asset pricing questions. To implement this identification strategy, researchers need to approximate the ranking variable used to assign stocks to indexes. We develop a procedure that predicts assignment to the Russell 1000/2000 with significant improvements relative to previous approaches. We apply this methodology to extend the tests in Ben-David, Franzoni, and Moussawi (2018).
    Keywords: Russell, institutional investors, ETFs, volatility
    JEL: G12 G14 G15
    Date: 2019–10
  9. By: Bevilaqua, Julia (Wharton School of Business); Hale, Galina (Federal Reserve Bank of San Francisco); Tallman, Eric (Federal Reserve Bank of San Francisco)
    Abstract: We document that positive association between corporate and sovereign cost of funds borrowed on global capital markets weakens during periods of unusually high sovereign yields, when corporate borrowers are able to issue debt that is priced at lower rates than sovereign debt. This state-dependent sensitivity of corporate yields to sovereign yields has not been previously documented in the literature. We demonstrate that this stylized fact is observed across countries and industries as well as for a given borrower over time and is not explained by a different composition of borrowers issuing debt during periods of high sovereign yields or by the relationship between corporate and sovereign credit ratings. We show that even if we exclude high-yield episodes that accompany financial crises and IMF programs, the sensitivity of corporate yields to sovereign yields is lower when sovereign yields are high. We propose a simple information model that rationalizes our empirical observations: when sovereign yields are high and more volatile, corporate yields are less sensitive to sovereign yields.
    JEL: E52 F34 F36 F65
    Date: 2019–09–24
  10. By: Copeland, Adam (Federal Reserve Bank of New York)
    Abstract: This paper measures how the 2007-09 financial crisis affected the U.S. federal funds market. I accomplish this by developing and estimating a structural model of this market, in which intermediation plays a crucial role and borrowing banks differ in their unobserved probability of default. The estimates imply that the expected probability of default increases 0.29 percentage point at the start of the crisis in mid-2007 and then gains a further 1.91 percentage points after the bankruptcy of Lehman Brothers. These increases do not cause a market freeze, however, because simultaneously there is a shift outward in the supply of funds. The model indicates that amid the turmoil of the crisis, lenders viewed the fed funds market as a relatively attractive place to invest cash overnight.
    Keywords: asymmetric information; fed funds; intermediation; financial crisis
    JEL: D82 G01 G14
    Date: 2019–11–01
  11. By: Massimo Guidolin; Manuela Pedio; Milena Petrova
    Abstract: We study the recursive, out-of-sample realized predictive performance of a rich set of predictor choices and models, spanning linear and Markov switching frameworks when the forecast target is represented by excess NCREIF and equity NAREIT returns. We find considerable pockets of predictive power, especially at the short- and intermediate horizons and for private real estate returns, both in absolute term and in comparison to a simple, but powerful, historical sample mean benchmark. We then test whether such forecasting accuracy may translate to positive, risk-adjusted out-of-sample performance in a recursive mean-variance portfolio allocation exercise, selecting weights of stocks, bonds, cash, and real estate (private or public). Consistently, we find that especially in the case of private real estate, significant improvements in realized Sharpe ratios and mean-variance utility scores are achieved from a range of strategies, exploiting predictability at intermediate horizons, especially when supported by Markov switching models. These results are robust the inclusion of transaction costs and extend to public real estate.
    Keywords: Public real estate, REITs, private real estate, predictability, mean-variance portfolios.
    Date: 2019

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