nep-fmk New Economics Papers
on Financial Markets
Issue of 2020‒08‒17
twenty-one papers chosen by

  1. Financial Market and Capital Flow Dynamics During the COVID-19 Pandemic By Beirne, John Beirne; Renzhi, Nuobu; Sugandi, Eric Alexander; Volz, Ulrich
  2. Predicting prices of S&P500 index using classical methods and recurrent neural networks By Mateusz Kijewski; Robert Ślepaczuk
  3. Predicting bond return predictability By Daniel Borup; Jonas N. Eriksen; Mads M. Kjær; Martin Thyrsgaard
  4. A Theory of Social Impact Bonds By Daniel L. Tortorice; David E. Bloom; Paige Kirby; John Regan
  5. Financial intermediation and technology: What’s old, what’s new? By Boot, Arnoud; Hoffmann, Peter; Laeven, Luc; Ratnovski, Lev
  6. Uncovering a factor-based expected return conditioning structure with Regression Trees jointly for many stocks By Vassilis Polimenis
  7. Managing the Maturity Structure of Marketable Treasury Debt: 1953-1983 By Kenneth D. Garbade
  8. Adjusted Expected Shortfall By Matteo Burzoni; Cosimo Munari; Ruodu Wang
  9. Gold and Oil Prices: Abnormal Returns, Momentum and Contrarian Effects By Guglielmo Maria Caporale; Alex Plastun
  10. Do Bank Insiders Impede Equity Issuances? By Martin Goetz; Luc Laeven; Ross Levine
  11. Systemic Risk-Shifting in Financial Networks By Elliott, M.; Georg, C-P.; Hazell, J.
  12. Common Short Selling and Excess Comovement By Geraci, M V.; Gnabo, J-V.; Veredas, D.
  13. Asset Prices and Capital Share Risks: Theory and Evidence By Byrne, Joseph P; Ibrahim, Boulis Maher; Zong, Xiaoyu
  14. Automated Market Makers By Mohsen Pourpouneh; Kurt Nielsen; Omri Ross
  15. Capital Market Financing and Firm Growth By Didier Brandao,Tatiana; Levine,Ross Eric; Llovet Montanes,Ruth; Schmukler,Sergio L.
  16. Artificial Neural Networks Performance in WIG20 Index Options Pricing By Maciej Wysocki; Robert Ślepaczuk
  17. Stock Return Predictability and Variance Risk Premia around the ZLB By Toshiaki Ogawa; Masato Ubukata; Toshiaki Watanabe
  18. The Role of Government and Private Institutions in Credit Cycles in the U.S. Mortgage Market By Manuel Adelino; William B. McCartney; Antoinette Schoar
  19. Is the Value Effect due to M&A Deals?: Evidence from the Italian Stock Market By Antonio Roma
  20. "Some Empirical Models of Japanese Government Bond Yields Using Daily Data" By Tanweer Akram; Huiqing Li
  21. Testing Semi-Strong Form Efficiency of the Prewar Japanese Stock Market By Kenichi Hirayama; Akihiko Noda

  1. By: Beirne, John Beirne (Asian Development Bank Institute); Renzhi, Nuobu (Asian Development Bank Institute); Sugandi, Eric Alexander (Asian Development Bank Institute); Volz, Ulrich (Asian Development Bank Institute)
    Abstract: We examine empirically the reaction of global financial markets across 38 economies to the COVID-19 outbreak, with a special focus on the dynamics of capital flow across 14 emerging market economies. Using daily data over the period 4 January 2010 to 30 April 2020 and controlling for a host of domestic and global macroeconomic and financial factors, we use a fixed effects panel approach and a structural VAR framework to show that emerging markets have been more heavily affected than advanced economies. In particular, emerging economies in Asia and Europe have experienced the sharpest impact on stocks, bonds, and exchange rates due to COVID-19, as well as abrupt and substantial capital outflows. Our results indicate that fiscal stimulus packages introduced in response to COVID-19, as well as quantitative easing by central banks, have helped to restore overall investor confidence through reducing bond yields and boosting stock prices. Our findings also highlight the role that global factors and developments in the world’s leading financial centers have on financial conditions in EMEs. Importantly, the impact of COVID-19 related quantitative easing measures by central banks in advanced countries, which helped to lower sovereign bond yields and prop up stock markets at home, extended to EMEs, notably in relation to stabilizing capital flow dynamics. While the ultimate resolution of COVID-19 may be expected to lead to a market correction as uncertainty declines, our impulse response analysis suggests that there may be some permanent effects on financial markets and capital flows as a result of COVID-19, particularly in EMEs.
    Keywords: COVID-19; financial markets; capital flows
    JEL: F32 F41 F62
    Date: 2020–06–26
  2. By: Mateusz Kijewski (Quantitative Finance Research Group; Faculty of Economic Sciences, University of Warsaw); Robert Ślepaczuk (Quantitative Finance Research Group; Faculty of Economic Sciences, University of Warsaw)
    Abstract: This study implements algorithmic investment strategies with buy/sell signals based on classical methods and recurrent neural network model (LSTM). The research compares the performance of investment algorithms on time series of S&P500 index covering 20 years of data from 2000 to 2020. This paper presents an approach for dynamic optimization of parameters during backtesting process by using rolling training-testing window. Every method was tested in terms of robustness to changes in parameters and evaluated by appropriate performance statistics e.g. Information Ratio, Maximum Drawdown, etc. Combination of signals from different methods was stable and outperformed benchmark of Buy & Hold strategy doubling its returns on the same level of risk. Detailed sensitivity analysis revealed that classical methods which used rolling training-testing window were significantly more robust to changes in parameters than LSTM model in which hyperparameters were selected heuristically.
    Keywords: : machine learning, recurrent neural networks, long short-term memory model, time series analysis, algorithmic investment strategies, systematic transactional systems, technical analysis, ARIMA model
    JEL: C4 C14 C45 C53 C58 G13
    Date: 2020
  3. By: Daniel Borup (Aarhus University, CREATES and the Danish Finance Institute (DFI)); Jonas N. Eriksen (Aarhus University, CREATES and the Danish Finance Institute (DFI)); Mads M. Kjær (Aarhus University and CREATES); Martin Thyrsgaard (Northwestern University and CREATES)
    Abstract: We document predictable shifts in bond return predictability. Bond returns are predictable in high (low) economic activity (uncertainty) states, implying that the expectations hypothesis of the term structure holds periodically. These predictable performance differences, established using a new multivariate test for equal conditional predictive ability, can be used in real-time to improve out-of-sample bond risk premia estimates and investors’ economic value by means of a novel dynamic forecast combination scheme. Consistent with standard financial theory, the resulting forecasts are strongly countercyclical and peaks in recessions. The empirical findings are explained within a non-linear term structure model.
    Keywords: Bond excess returns, forecasting, state-dependencies, multivariate test, equal conditional predictive ability
    JEL: C12 C52 E43 E44 G12
    Date: 2020–08–04
  4. By: Daniel L. Tortorice; David E. Bloom; Paige Kirby; John Regan
    Abstract: Social impact bonds (SIBs) are an innovative financing mechanism for public goods. In a SIB, an investor provides capital to a service provider for a social intervention. The investor receives a return based on the outcome of the intervention relative to a predetermined benchmark. We describe the basic structure of a SIB and provide some descriptive statistics for these financial instruments. We then consider a formal model of SIBs and examine their ability to finance positive net present value projects that traditional debt finance cannot. We find that SIBs expand the set of implementable projects if governments are pessimistic (relative to the private sector) about the probability an intervention would succeed or if the government is particularly averse to paying costs associated with a project that does not generate offsetting benefits. As both these features are present in various public programs, we conclude that SIBs are a real innovation in public finance and should be considered for projects when traditional debt finance has been rejected.
    JEL: G12 H41
    Date: 2020–07
  5. By: Boot, Arnoud; Hoffmann, Peter; Laeven, Luc; Ratnovski, Lev
    Abstract: We study the effects of technological change on financial intermediation, distinguishing between innovations in information (data collection and processing) and communication (relationships and distribution). Both follow historic trends towards an increased use of hard information and less in-person interaction, which are accelerating rapidly. We point to more recent innovations, such as the combination of data abundance and artificial intelligence, and the rise of digital platforms. We argue that in particular the rise of new communication channels can lead to the vertical and horizontal disintegration of the traditional bank business model. Specialized providers of financial services can chip away activities that do not rely on access to balance sheets, while platforms can interject themselves between banks and customers. We discuss limitations to these challenges, and the resulting policy implications. JEL Classification: G20, G21, E58, O33
    Keywords: communication, financial innovation, financial intermediation, fintech, information
    Date: 2020–07
  6. By: Vassilis Polimenis
    Abstract: Given the success and almost universal acceptance of the simple linear regression three-factor model, it is interesting to analyze the informational content of the three factors in explaining stock returns when the analysis is allowed to consider non-linear dependencies between factors and stock returns. In order to better understand factor-based conditioning information with respect to expected stock returns within a regression tree setting, the analysis of stock returns is demonstrated using daily stock return data for 5 major US corporations. The first finding is that in all cases (solo and joint) the most informative factor is always the market excess return factor. Further, three major issues are discussed: a) the balance of a depth=1 tree as it relates to properties of the stock return distribution, b) the mechanism behind depth=1 tree balance in a joint regression tree and c) the dominant stock in a joint regression tree. It is shown that high skew values alone cannot explain the imbalance of the resulting tree split as stocks with pronounced skew may produce balanced tree splits.
    Date: 2020–07
  7. By: Kenneth D. Garbade
    Abstract: This paper examines the evolution of the maturity structure of marketable Treasury debt from 1953 to 1983. Average maturity contracted erratically from 1953 to 1960, expanded through mid-1965, contracted again through late 1975, and then expanded into the early 1980s. What accounts for these broad trends? In particular, what were the maturity objectives of Treasury debt managers? Were they able to achieve their objectives? Why or why not?
    Keywords: Treasury debt management; maturity structure of debt; advance refundings
    JEL: G28 H63 N22
    Date: 2020–07–01
  8. By: Matteo Burzoni; Cosimo Munari; Ruodu Wang
    Abstract: We introduce and study the main properties of a class of convex risk measures that refine Expected Shortfall by simultaneously controlling the expected losses associated with different portions of the tail distribution. The corresponding adjusted Expected Shortfalls quantify risk as the minimum amount of capital that has to be raised and injected into a financial position $X$ to ensure that Expected Shortfall $ES_p(X)$ does not exceed a pre-specified threshold $g(p)$ for every probability level $p\in[0,1]$. Through the choice of the benchmark risk profile $g$ one can tailor the risk assessment to the specific application of interest. We devote special attention to the study of risk profiles defined by the Expected Shortfall of a benchmark random loss, in which case our risk measures are intimately linked to second-order stochastic dominance.
    Date: 2020–07
  9. By: Guglielmo Maria Caporale; Alex Plastun
    Abstract: This paper explores price (momentum and contrarian) effects on the days characterised by abnormal returns and the following ones in two commodity markets. Specifically, using daily Gold and Oil price data over the period 01.01.2009-31.03.2020 the following hypotheses are tested: H1) there are price effects on days with abnormal returns, H2) there are price effects on the day after abnormal returns occur; H3) the price effects caused by abnormal returns are exploitable. For these purposes average analysis, t-tests, CAR and trading simulation approaches are used. The main results can be summarised as follows. Hourly returns during the day of abnormal returns are significantly bigger than those during average “normal” days. Prices tend to move in the direction of abnormal returns till the end of the day when these occur. The presence of abnormal returns can usually be detected before the end of the day by estimating specific timing parameters, and a momentum effect can be detected. On the following day two different price patterns are detected: a momentum effect for Oil prices and a contrarian effect for Gold prices respectively. Trading simulations show that these effects can be exploited to generate abnormal profits.
    Keywords: commodities, anomalies, momentum effect, contrarian effect, abnormal returns
    JEL: G12 G17 C63
    Date: 2020
  10. By: Martin Goetz; Luc Laeven; Ross Levine
    Abstract: We evaluate the role of insider ownership in shaping banks’ equity issuances in response to the global financial crisis. We construct a unique dataset on the ownership structure of U.S. banks and their equity issuances and discover that greater insider ownership leads to less equity issuances. Several tests are consistent with the view that bank insiders are reluctant to reduce their private benefits of control by diluting their ownership through equity issuances. Given the connection between bank equity and lending, the results stress that ownership structure can shape the resilience of banks—and hence the entire economy—to aggregate shocks.
    JEL: G21 G28 G32
    Date: 2020–06
  11. By: Elliott, M.; Georg, C-P.; Hazell, J.
    Abstract: Banks face different but potentially correlated risks from outside the financial system. Financial connections can share these risks, but also create the means by which shocks can propagate. We examine this tradeoff in the context of a new stylised fact we present: German banks are more likely to have financial connections when they face more similar risks—potentially undermining the risk sharing role of financial connections and contributing to systemic risk. We find that such patterns are socially suboptimal, but can be explained by risk-shifting. Risk-shifting motivates banks to correlate their failures with their counterparties, even though it creates systemic risk.
    Keywords: financial networks, asset correlation, contagion
    JEL: G21 G11 D85
    Date: 2020–07–20
  12. By: Geraci, M V.; Gnabo, J-V.; Veredas, D.
    Abstract: We show that common short sold capital can explain future six-factor excess return correlation one month ahead, controlling for many pair characteristics, including similarities in size, book-to-market, and momentum. We explore the possible mechanisms that could ruse to this relationship. We find that the asset class effect cannot explain the uncovered relationship. Rather, the relationship is consistent with the information diffusions view of comovement, which we identify using additional profiling data for short sellers.
    Keywords: short selling, correlation, informed trading, hedge funds
    JEL: G14
    Date: 2020–07–05
  13. By: Byrne, Joseph P; Ibrahim, Boulis Maher; Zong, Xiaoyu
    Abstract: An asset pricing model using long-run capital share growth risk has recently been found to successfully explain U.S. stock returns. Our paper adopts a recursive preference utility framework to derive an heterogeneous asset pricing model with capital share risks.While modeling capital share risks, we account for the elevated consumption volatility of high income stockholders. Capital risks have strong volatility effects in our recursive asset pricing model. Empirical evidence is presented in which capital share growth is also a source of risk for stock return volatility. We uncover contrasting unconditional and conditional asset pricing evidence for capital share risks.
    Keywords: Asset Pricing, Capital Share, Recursive Preference, Consumption Growth, Bayesian Methods.
    JEL: C21 C30 E25 G11 G12
    Date: 2020–05–12
  14. By: Mohsen Pourpouneh (Department of Food and Resource Economics, University of Copenhagen); Kurt Nielsen (Department of Food and Resource Economics, University of Copenhagen); Omri Ross (eToroX Labs, University of Copenhagen)
    Abstract: A new type of Automated Market Makers (AMMs) powered by Blockchain technology keep liquidity on-chain and offer transparent price mechanisms. This innovation is a significant step in the direction of building a more transparent and efficient financial market. This paper explores analytically market mechanisms and shows the conditions when those mechanisms are equivalent. Furthermore, we show that AMM mechanisms inherently create loses for market makers from inefficient prices (dictated by the AMM solutions), however, these mechanisms work well for assets with low volatility. We further analytically explore the losses and quantify them. The paper ends by discussing the design of efficient decentralized exchange compared to traditional Central Limited Order Books (CLOBs) and highlights the former’s potential regarding decentralized finance.
    Keywords: blockchain, decentralized exchanges, automated liquidity providers, auction, mechanism design
    JEL: D53 G12
    Date: 2020–07
  15. By: Didier Brandao,Tatiana; Levine,Ross Eric; Llovet Montanes,Ruth; Schmukler,Sergio L.
    Abstract: This paper studies whether there is a connection between finance and growth at the firm level. It employs a new dataset of 150,165 equity and bond issuances around the world, matched with income and balance sheet data for 62,653 listed firms in 65 countries over 1990-2016. Three main patterns emerge from the analyses. First, firms that choose to issue in capital markets use the funds raised to grow by enhancing their productive capabilities, increasing their tangible and intangible capital and the number of employees. Growth accelerates as firms raise funds. Second, the faster growth is more pronounced among firms that are more likely to face tighter financing constraints, namely, small, young, and high-R&D firms. Third, capital market issuances are associated with faster growth among firms located in countries with more developed capital markets relative to banks. Capital markets are also comparatively effective at allowing financially constrained firms to raise capital.
    Keywords: Financial Sector Policy,Capital Markets and Capital Flows,Capital Flows,Financial Economics,Finance and Development,Mining&Extractive Industry (Non-Energy)
    Date: 2020–07–27
  16. By: Maciej Wysocki (Quantitative Finance Research Group; Faculty of Economic Sciences, University of Warsaw); Robert Ślepaczuk (Quantitative Finance Research Group; Faculty of Economic Sciences, University of Warsaw)
    Abstract: In this paper the performance of artificial neural networks in option pricing is analyzed and compared with the results obtained from the Black – Scholes – Merton model based on the historical volatility. The results are compared based on various error metrics calculated separately between three moneyness ratios. The market data-driven approach is taken in order to train and test the neural network on the real-world data from the Warsaw Stock Exchange. The artificial neural network does not provide more accurate option prices. The Black – Scholes – Merton model turned out to be more precise and robust to various market conditions. In addition, the bias of the forecasts obtained from the neural network differs significantly between moneyness states.
    Keywords: option pricing, machine learning, artificial neural networks, implied volatility, supervised learning, index options, Black – Scholes – Merton model
    JEL: C4 C14 C45 C53 C58 G13
    Date: 2020
  17. By: Toshiaki Ogawa (Deputy Director and Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:; Masato Ubukata (Professor, Faculty of Economics, Meiji Gakuin University (E-mail:; Toshiaki Watanabe (Professor, Institute of Economic Research, Hitotsubashi University (E-mail:
    Abstract: We make an empirical analysis of whether and how variance risk premia (VRP) contribute to predicting excess stock returns in the US and Japan. Our new findings to be added to the literature are that (i) the correlation between VRP and future excess returns in the US is insignificant when the risk-free rate is close to zero, and (ii) the correlation in Japan is significantly negative. To explain these findings, we also conduct a preliminary theoretical analysis with a structural model of asset pricing based on two assumptions: the zero lower bound ( ZLB) for the risk-free rate, and a negative correlation between the consumption growth rate and the volatility-of-volatility. These allow excess returns to follow a hump-shaped pattern. This affects the sign and significance of the correlation of the returns with the VRP.
    Keywords: Excess returns, Heterogeneous autoregressive model, Nikkei 225, Realized volatility, S&P500, Variance risk premium, Zero lower bound
    JEL: C52 C53 G17
    Date: 2020–07
  18. By: Manuel Adelino; William B. McCartney; Antoinette Schoar
    Abstract: We show that the distribution of combined loan-to-value ratios (CLTVs) for purchase mortgages in the U.S. has been remarkably stable over the last 25 years. But there was a dramatic shift during the housing boom of the 2000s in the provision of high- CLTV loans through private sources, which replaced almost one-for-one the share of high-CLTV loans directly guaranteed by the government, via FHA and VA. Post 2008, FHA/VA loans increased back to 30% of all purchase mortgages. This substitution between government and privately backed high-CLTV loans holds within ZIP codes, properties and borrower types over the full sample period. We also show that the increase in private high-CLTV lending follows local house price increases rather than preceding them. These findings suggest that the housing boom was not accompanied by a shift towards more high-CLTV loans, and instead favor models that rely on changes in collateral values or broad changes in house price expectations.
    JEL: E03 G21 G28 G30 R30
    Date: 2020–07
  19. By: Antonio Roma
    Abstract: The paper provides an empirical characterisation of the value effect detected on the Italian Stock Market in the sample period 2000-2018 based on the value premium offered for the acquisition of a value stock. A bid on a value stock generates a large and statistically significant average return on the holding of the target in the deal window, as opposed to bids on growth stocks. Returns on stocks which are the target of a bid accounts for up to two thirds of the average return on the long side of the Fama and French (1993) HML portfolio. The other significant component of the average return of HML is due to the short selling of small growth stocks, which, as evidenced in previous literature, is often difficult to implement from a practical point of view.
    Keywords: Fama-French model; value effect; merger arbitrage
    JEL: G11 G12
    Date: 2020–06
  20. By: Tanweer Akram; Huiqing Li
    Abstract: This paper models the dynamics of Japanese government bond (JGB) nominal yields using daily data. Models of government bond yields based on daily data, such as those presented in this paper, can be useful not only to investors and market analysts, but also to central bankers and other policymakers for assessing financial conditions and macroeconomic developments in real time. The paper shows that long-term JGB nominal yields can be modeled using the short-term interest rate on Treasury bills, the equity index, the exchange rate, commodity price index, and other key financial variables.
    Keywords: Japanese Government Bonds; JGBs; Long-Term Interest Rates; Nominal Bond Yields; Monetary Policy; Bank of Japan; John Maynard Keynes
    JEL: E43 E50 E58 E60 G10 G12
  21. By: Kenichi Hirayama; Akihiko Noda
    Abstract: This paper examines Fama's (1970) semi-strong form efficient market hypothesis (EMH) in the prewar Japanese stock market using a new dataset. We particularly focus on the relationship between the prewar Japanese stock market and several government policy interventions to explore whether the semi-strong form stock market efficiency evolves over time. To capture the long-run impact of government policy interventions against stock markets, we measure the time-varying joint degree of market efficiency and the time-varying impulse responses based on Ito et al.'s (2014; 2017) generalized least squares-based time-varying vector autoregressive model. The empirical results reveal that (1) the joint degree of market efficiency in the prewar Japanese stock market fluctuated over time because of external events such as policy changes and wars, (2) the semi-strong form EMH is almost supported in the prewar Japanese stock market, and (3) the markets rapidly reflect the information of the external events through time. Therefore, we conclude that Lo's (2004) adaptive market hypothesis is supported in the prewar Japanese stock market even if we consider that the public information affects the stock market.
    Date: 2020–08

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