nep-fmk New Economics Papers
on Financial Markets
Issue of 2021‒08‒30
thirteen papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Firm-level Business Uncertainty and the Predictability of the Aggregate U.S. Stock Market Volatility during the COVID-19 Pandemic By Riza Demirer; Rangan Gupta; Afees A. Salisu; Renee van Eyden
  2. Financial crises: A survey By Amir Sufi; Alan M. Taylor
  3. The Fed Explained By Raul Anibal Feliz
  4. Stock Price Level Effect By Borsboom, Charlotte; Füllbrunn, Sascha
  5. The RQE-CAPM : New insights about the pricing of idiosyncratic risk By Benoît Carmichael; Gilles Boevi Koumou; Kevin Moran
  6. The Treasury Market in Spring 2020 and the Response of the Federal Reserve By Annette Vissing-Jorgensen
  7. Continuous-time Portfolio Optimization for Absolute Return Funds By Masashi Ieda
  8. Market Crash Prediction Model for Markets in A Rational Bubble By HyeonJun Kim
  9. Does financial inclusion reduce non-performing loans and loan loss provisions? By Ozili, Peterson Kitakogelu; Adamu, Ahmed
  10. Cryptocurrencies: An empirical view from a Tax Perspective By Andreas Thiemann
  11. The Risk Premia of Energy Futures By Adrian Fernandez-Perez; Ana-Maria Fuertes; Joelle Miffre
  12. Deep Sequence Modeling: Development and Applications in Asset Pricing By Lin William Cong; Ke Tang; Jingyuan Wang; Yang Zhang
  13. The Dynamics of the U.S. Overnight Triparty Repo Market By Matthew McCormick; Mark E. Paddrik; Carlos Ramirez

  1. By: Riza Demirer (Department of Economics and Finance, Southern Illinois University Edwardsville, Edwardsville, IL 62026- 1102, USA); Rangan Gupta (Department of Economics, University of Pretoria, Private Bag X20, Hatfield 0028, South Africa); Afees A. Salisu (Centre for Econometric & Allied Research, University of Ibadan, Ibadan, Nigeria; Department of Economics, University of Pretoria, Private Bag X20, Hatfield 0028, South Africa); Renee van Eyden (Department of Economics, University of Pretoria, Private Bag X20, Hatfield 0028, South Africa)
    Abstract: In this paper, we analyze the predictive role of firm-level business expectations and uncertainties derived from a panel survey of U.S. 1,750 business executives from 50 states for the realized variance (sum of daily squared log-returns over a month) of the S&P500 over the monthly period of September, 2016 to July, 2021. Unlike standard models, our predictive framework adopts a time-varying approach due to the existence of multiple structural breaks in the relationship between volatility and the predictors in the model, which in turn leads to statistically insignificant causal effects in a constant parameter set-up. Our time-varying results reveal the predictive power of firm-level business uncertainty is concentrated during the early part of the sample associated with the U.S.-China trade war, and towards the end of our data coverage in the wake of the outbreak of the COVID-19 pandemic. Since, in-sample predictability does not guarantee the same over an out-sample, we also conducted a full-fledged forecasting exercise to show that subjective expectations and uncertainties associated with sales growth rates and employment produces statistically significant predictability gains over January, 2020 to July, 2021, given an in-sample of September, 2016 to December, 2019. Our results suggest that subjective measures of business uncertainty at the firm-level indeed captures predictive information regarding aggregate stock market uncertainty which has important implications for investors and economic projections at the policy level.
    Keywords: S&P500 Realized Variance, Firm-Level Expectations and Uncertainties, Time-Varying Predictability
    JEL: C32 C53 D80 G10
  2. By: Amir Sufi; Alan M. Taylor
    Abstract: Financial crises have large deleterious effects on economic activity, and as such have been the focus of a large body of research. This study surveys the existing literature on financial crises, exploring how crises are measured, whether they are predictable, and why they are associated with economic contractions. Historical narrative techniques continue to form the backbone for measuring crises, but there have been exciting developments in using quantitative data as well. Crises are predictable with growth in credit and elevated asset prices playing an especially important role; recent research points convincingly to the importance of behavioral biases in explaining such predictability. The negative consequences of a crisis are due to both the crisis itself but also to the imbalances that precede a crisis. Crises do not occur randomly, and, as a result, an understanding of financial crises requires an investigation into the booms that precede them.
    JEL: E32 E44 E7 G01 G10 N20
    Date: 2021–08
  3. By: Raul Anibal Feliz
    Abstract: The 11th edition of The Fed Explained: What the Central Bank Does (formerly The Federal Reserve System Purposes & Functions) details the structure, responsibilities, and work of the U.S. central banking system. The Federal Reserve System performs five functions to promote the effective operation of the U.S. economy and, more generally, to serve the public interest. It includes three key entities: the Board of Governors, 12 Federal Reserve Banks, and the Federal Open Market Committee.
    Date: 2021–08–11
  4. By: Borsboom, Charlotte; Füllbrunn, Sascha
    Abstract: Companies actively manipulate stock price ranges through IPOs, stock splits, and repurchases. Indeed, empirical results suggest that the stock's price range, whether at a high or low price level, affects market performance. Unfortunately, archival data does not allow us to test the effect of stock price levels on investor behavior due to uncontrolled confound effects. We thus conduct a controlled online experiment with 900 US retail investors to test whether a difference in stock price levels affects the investor's risk perception, the price forecast, and the investment. Even though we �nd no differences in risk perception and forecasts, our results show signi�cantly higher investments in high-priced stocks in comparison to low-priced stocks. This effect disappears when we allow fractional share purchases or restrict naive trading strategies.
    Keywords: stock price, nominal stock price puzzle, stock splits, number processing, fractional share purchases, naive trading strategies, numerosity
    JEL: C90 D14 G11
    Date: 2021–08–18
  5. By: Benoît Carmichael; Gilles Boevi Koumou; Kevin Moran
    Abstract: We use an equivalent form of Markowitz's mean-variance utility function, based on Rao's Quadratic Entropy (RQE), to enrich the standard capital asset pricing model (CAPM), both in the presence and in the absence of a risk-free asset. The resulting equilibrium, which we denote RQE-CAPM, offers important new insights about the pricing of risk. Notably, it reveals that the reason for which the standard CAPM does not price idiosyncratic risk is not only because the market portfolio is law of large numbers diversifed but also because the model implicitly assumes agents' total risk aversion and their correlation diversifcation risk preference balance each other exactly. We then demonstrate that idiosyncratic risk is priced in a general RQE-CAPM where agents' total risk aversion and their correlation diversifcation risk preference coeffcients are not necessary equal. Our general RQE-CAPM therefore offers a unifying way of thinking about the pricing of idiosyncratic risk, including cases where such risk is negatively priced, and is relevant for the literature assessing the idiosyncratic risk puzzle. It also provides a natural theoretical underpinning for the empirical tests of the CAPM or the pricing of idiosyncratic risk performed in some existence studies. Nous utilisons une forme équivalente de la fonction d'utilité moyenne-variance de Markowitz, basée sur l'entropie quadratique de Rao (RQE), pour enrichir le modèle standard d'évaluation des actifs financiers (CAPM), à la fois en présence et en l'absence d'un actif sans risque. L'équilibre qui en résulte, que nous désignons par RQE-CAPM, offre de nouvelles perspectives importantes sur l'évaluation du risque. Il révèle notamment que la raison pour laquelle le CAPM standard n'évalue pas le risque idiosyncratique n'est pas seulement due au fait que le portefeuille du marché est diversifié par la loi des grands nombres, mais aussi au fait que le modèle suppose implicitement que l'aversion totale au risque des agents et leur préférence pour le risque de diversification de la corrélation s'équilibrent exactement. Nous démontrons ensuite que le risque idiosyncratique est évalué dans un RQE-CAPM général où l'aversion totale au risque des agents et leurs coefficients de préférence pour le risque de diversification de la corrélation ne sont pas nécessairement égaux. Notre modèle RQE-CAPM général offre donc une façon unifiée de penser à la tarification du risque idiosyncratique, y compris les cas où ce risque est évalué négativement, et est pertinent pour la littérature évaluant l'énigme du risque idiosyncratique. Il fournit également une base théorique naturelle pour les tests empiriques du MEDAF ou de la tarification du risque idiosyncratique effectués dans certaines études d'existence.
    Keywords: Rao's Quadratic Entropy,Mean-Variance Model,Capital Asset Pricing Model,Idiosyncratic Risk,Correlation Diversiffcation, Entropie quadratique de Rao,modèle moyenne-variance,modèle d'évaluation des actifs financiers,risque idiosyncratique,corrélation et diversification
    JEL: G11 G12
    Date: 2021–08–23
  6. By: Annette Vissing-Jorgensen
    Abstract: Treasury yields spiked during the initial phase of COVID. The 10-year yield increased by 64 bps from March 9 to 18, 2020, leading the Federal Reserve to purchase $1T of Treasuries in 2020Q1. Fed purchases were causal for reducing Treasury yields based on the timing of purchases (which increased on March 19), the timing of yield reversal and Fed purchases in the MBS market, and evidence against confounding factors. Treasury-QE worked more via purchases than announcements. The yield spike was driven by liquidity needs of mutual funds, foreign official agencies, and hedge funds that were unaffected by the March 15 Treasury-QE announcement.
    JEL: E5 G12
    Date: 2021–08
  7. By: Masashi Ieda
    Abstract: This paper investigates a continuous-time portfolio optimization problem with the following features: (i) a no-short selling constraint; (ii) a leverage constraint, that is, an upper limit for the sum of portfolio weights; and (iii) a performance criterion based on the lower mean square error between the investor's wealth and a predetermined target wealth level. Since the target level is defined by a deterministic function independent of market indices, it corresponds to the criterion of absolute return funds. The model is formulated using the stochastic control framework with explicit boundary conditions. The corresponding Hamilton-Jacobi-Bellman equation is solved numerically using the kernel-based collocation method. However, a straightforward implementation does not offer a stable and acceptable investment strategy; thus, some techniques to address this shortcoming are proposed. By applying the proposed methodology, two numerical results are obtained: one uses artificial data, and the other uses empirical data from Japanese organizations. There are two implications from the first result: how to stabilize the numerical solution, and a technique to circumvent the plummeting achievement rate close to the terminal time. The second result implies that leverage is inevitable to achieve the target level in the setting discussed in this paper.
    Date: 2021–08
  8. By: HyeonJun Kim
    Abstract: Renowned method of log-periodic power law(LPPL) is one of the few ways that a financial market crash could be predicted. Alongside with LPPL, this paper propose a novel method of stock market crash using white box model derived from simple assumptions about the state of rational bubble. By applying this model to Dow Jones Index and Bitcoin market price data, it is shown that the model successfully predicts some major crashes of both markets, implying the high sensitivity and generalization abilities of the model.
    Date: 2021–08
  9. By: Ozili, Peterson Kitakogelu; Adamu, Ahmed
    Abstract: We examine whether countries that have high levels of financial inclusion have fewer non-performing loans and loan loss provisions in their banking sectors. The fixed effect panel regression methodology was used to analyse the effect of financial inclusion on bank non-performing loans and loan loss provisions. Using data from 48 countries, we find that greater formal account ownership is associated with high non-performing loans. Bank loan loss provisions are fewer in countries that have high levels of financial inclusion only when financial inclusion is achieved through the combined use of formal account ownership, bank branch supply and ATM supply. Also, non-performing loans are fewer in countries that experience economic boom and high levels of financial inclusion.
    Keywords: financial inclusion, non-performing loans, loan loss provisions, financial stability, bank stability, ATM, formal account ownership, credit risk, access to finance.
    JEL: G00 G20 G21 G23 G28 G29 O31
    Date: 2021–08
  10. By: Andreas Thiemann (European Commission - JRC)
    Abstract: This paper sheds light on the scarce empirical evidence on cryptocurrency users and use types. Based on the only available empirical estimate (shared by Chainalysis), this paper simulates the revenue potential from taxing Bitcoin capital gains in the EU. Total estimated Bitcoin capital gains in the EU amount to 12.7 billion EUR in 2020, including 3.6 billion EUR of realized gains. Applying national tax rules on capital gains from shares to those from Bitcoin yields a simulated tax revenue of about 850 million EUR in 2020. This paper is the first to empirically assess the tax revenue potential of capital gains from Bitcoin in the EU. While most of the empirical cryptocurrency literature is based on time-series data, this paper relies on dis-aggregated country-level data. The findings show that revenue from taxing cryptocurrencies is non-negligible and will be if the market of cryptocurrencies continues to grow.
    Keywords: Capital gains taxation, cryptocurrencies, Bitcoin.
    JEL: G19 G23 H24
    Date: 2021–08
  11. By: Adrian Fernandez-Perez (AUT - Auckland University of Technology); Ana-Maria Fuertes (Sir John Cass Business School); Joelle Miffre (Audencia Business School)
    Abstract: This paper studies the energy futures risk premia that can be extracted through long-short portfolios that exploit heterogeneities across contracts as regards various characteristics or signals and integrations thereof. Investors can earn a sizeable premium of about 8% and 12% per annum by exploiting the energy futures contract risk associated with the hedgers' net positions and roll-yield characteristics, respectively, in line with predictions from the hedging pressure hypothesis and theory of storage. Simultaneously exploiting various signals towards style-integration with alternative weighting schemes further enhances the premium. In particular, the style-integrated portfolio that equally weights all signals stands out as the most effective. The findings are robust to transaction costs, data mining and sub-period analyses.
    Keywords: Integration,Long-short portfolios,Risk premium,Energy futures markets
    Date: 2021–10–01
  12. By: Lin William Cong; Ke Tang; Jingyuan Wang; Yang Zhang
    Abstract: We predict asset returns and measure risk premia using a prominent technique from artificial intelligence -- deep sequence modeling. Because asset returns often exhibit sequential dependence that may not be effectively captured by conventional time series models, sequence modeling offers a promising path with its data-driven approach and superior performance. In this paper, we first overview the development of deep sequence models, introduce their applications in asset pricing, and discuss their advantages and limitations. We then perform a comparative analysis of these methods using data on U.S. equities. We demonstrate how sequence modeling benefits investors in general through incorporating complex historical path dependence, and that Long- and Short-term Memory (LSTM) based models tend to have the best out-of-sample performance.
    Date: 2021–08
  13. By: Matthew McCormick; Mark E. Paddrik; Carlos Ramirez
    Abstract: The overnight segment of the triparty repurchase agreement (repo) market plays a pivotal role in the normal functioning of the U.S. financial system by acting as an important source of secured short-term funding and supporting the liquidity of key fixed income markets, including U.S. Treasury and agency securities. This over-the-counter market accounts for over $1 trillion in daily transactions and provides a unique venue in which a diverse set of market participants invest their cash as well as obtain short-term funding.
    Date: 2021–08–02

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