nep-fmk New Economics Papers
on Financial Markets
Issue of 2020‒06‒08
six papers chosen by

  1. COVID-19 and Financial Markets: A Panel Analysis for European Countries By Jens Klose; Peter Tillmann
  2. The Federal Reserve's Liquidity Backstops to the Municipal Bond Market during the COVID-19 Pandemic By Bin Wei; Vivian Z. Yue
  3. Predicting the Long-term Stock Market Volatility: A GARCH-MIDAS Model with Variable Selection By Tong Fang; Tae-Hwy Lee; Zhi Su
  4. Credit Rating Downgrade Risk on Equity Returns By Periklis Brakatsoulas; Jiri Kukacka
  5. Measuring the Perceived Liquidity of the Corporate Bond Market By Sergey Chernenko; Adi Sunderam
  6. The interbank market puzzle By Allen, Franklin; Covi, Giovanni; Gu, Xian; Kowalewski, Oskar; Montagna, Mattia

  1. By: Jens Klose (THM Business School Giessen); Peter Tillmann (Justus Liebig University Giessen)
    Abstract: In order to fight the economic consequences of the COVID-19 pandemic, monetary and fiscal policy announced a large variety of support packages which are often unprecedented in size. In this paper, we provide an empirical analysis of the responses of European financial markets to these policy announcements. The key contribution is a very granular set of policy announcements, both at the national and the European level. We also differentiate between the first announcement in a series of policies and the subsequent announcements because the initial steps were often seen as bad news about the state of the economy. In a panel model we find that monetary policy, in particular through asset purchases, is effective in supporting the real economy and easing the pressure on governmental finances. Across all subsets of polices, it seems that monetary policy is more effective in supporting the stock market than national fiscal policy, though markets clearly distinguish between different types of policies.
    Keywords: event study, announcements, fiscal policy, monetary policy, European Monetary Union
    JEL: E44 E52 E62
    Date: 2020
  2. By: Bin Wei; Vivian Z. Yue
    Abstract: The COVID-19 pandemic has caused tremendous hardship all over the world. In response, the Federal Reserve has moved quickly and aggressively to support the economy in the United States. In this article, we present some initial evidence for the effectiveness of some of the facilities in calming the municipal bond market, particularly the short-term variable-rate demand obligation (VRDO) market. We discuss the important role of liquidity backstops in mitigating runs and stabilizing financial markets in general based on insights from our study on the runs on VRDO and auction-rate securities (ARS) in 2008 during the financial crisis.
    Keywords: municipal bond; COVID-19 pandemic; liquidity backstops
    JEL: G10 G20 G21
    Date: 2020–05–28
  3. By: Tong Fang (Shandong University); Tae-Hwy Lee (Department of Economics, University of California Riverside); Zhi Su (Central University of Finance and Economics)
    Abstract: We consider a GARCH-MIDAS model with short-term and long-term volatility components, in which the long-term volatility component depends on many macroeconomic and financial variables. We select the variables that exhibit the strongest effects on the long-term stock market volatility via maximizing the penalized log-likelihood function with an Adaptive-Lasso penalty. The GARCH-MIDAS model with variable selection enables us to incorporate many variables in a single model without estimating a large number of parameters. In the empirical analysis, three variables (namely, housing starts, default spread and realized volatility) are selected from a large set of macroeconomic and financial variables. The recursive out-of-sample forecasting evaluation shows that variable selection significantly improves the predictive ability of the GARCH-MIDAS model for the long-term stock market volatility.
    Keywords: Stock market volatility, GARCH-MIDAS model, Variable selection, Penalized maximum likelihood, Adaptive-Lasso
    JEL: C32 C51 C53 G12
    Date: 2020–05
  4. By: Periklis Brakatsoulas (Institute of Economic Studies, Faculty of Social Sciences, Charles University Opletalova 26, 110 00, Prague, Czech Republic; Institute of Information Theory and Automation of the Czech Academy of Sciences, Pod Vodarenskou vezi 4, 182 00 Prague 8, Czech Republic); Jiri Kukacka (Institute of Economic Studies, Faculty of Social Sciences, Charles University Opletalova 26, 110 00, Prague, Czech Republic)
    Abstract: We develop a four-factor model intended to capture size, value, and credit rating transition patterns in excess returns for a panel of predominantly mid- and large-cap entities. Using credit transition matrices and rating histories from 48 US issuers, we provide evidence to support a statistically significant negative downgrade risk premium in excess returns, suggesting that stocks at higher risk of failure tend to deliver lower returns. The performance of the model remains robust across several estimation methods. Panel Granger causality test results indicate that there indeed is a Granger-causal relationship from credit rating transition probabilities to excess returns. Our paper thus provides a new methodology to generate firm-level downgrade probabilities and the basis for further empirical validation and development of Fama-French-type models under financial distress.
    Keywords: Asset pricing, credit risk, panel data, stock returns, transition matrices.
    JEL: G11 G12 G14
    Date: 2020–05
  5. By: Sergey Chernenko; Adi Sunderam
    Abstract: We propose a novel measure of bond market liquidity that does not depend on transaction data: the strength of the cross-sectional relationship between mutual fund cash holdings and fund flow volatility. Our measure captures how liquid funds perceive their portfolio holdings to be at a given point in time. The perceived liquidity of speculative grade and Rule 144A bonds is significantly lower than investment grade bonds in the cross section and deteriorated significantly following the 2008-9 financial crisis. Our measure can be applied in settings where either transaction data are not available or transactions are rare, including the markets for asset-backed securities, syndicated loans, and municipal bonds.
    JEL: G12 G23
    Date: 2020–05
  6. By: Allen, Franklin (Imperial College London); Covi, Giovanni (Bank of England); Gu, Xian (Wharton School of University of Pennsylvania.); Kowalewski, Oskar (IESEG School of Management); Montagna, Mattia (European Central Bank)
    Abstract: This study documents significant differences in the interbank market lending and borrowing levels across countries. We argue that the existing differences in interbank market usage can be explained by the trust of the market participants in the stability of the country’s banking sector and counterparties, proxied by the history of banking crises and failures. Specifically, banks originating from a country that has lower level of trust tend to have lower interbank borrowing. Using a proprietary dataset on bilateral exposures, we investigate the Euro Area interbank network and find the effect of trust relies on the network structure of interbank markets. Core banks acting as interbank intermediaries in the network are more significantly influenced by trust in obtaining interbank funding, while being more exposed in a community can mitigate the negative effect of low trust. Country-level institutional factors might partially substitute for the limited trust and enhance interbank activity.
    Keywords: Interbank market; trust; networks; centrality; community detection
    JEL: G01 G21 G28
    Date: 2020–05–14

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