nep-fmk New Economics Papers
on Financial Markets
Issue of 2022‒09‒12
eleven papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Are Equity Option Returns Abnormal? IPCA Says No By Amit Goyal; Alessio Saretto
  2. The Determinants of Bank Liquid Asset Holdings By René M. Stulz; Alvaro G. Taboada; Mathijs A. van Dijk
  3. Intermediary Balance Sheets and the Treasury Yield Curve By Du, Wenxin; Hebert, Benjamin; Li, Wenhao
  4. Operating Hedge and Gross Profitability Premium By Leonid Kogan; Jun Li; Harold Zhang
  5. The certification role of the EU-wide stress testing exercises in the stock market. What can we learn from the stress tests (2014-2021)? By Durrani, Agha; Ongena, Steven; Ponte Marques, Aurea
  6. Expectations and term premia in EFSF bond yields By Andrea Carriero; Lorenzo Ricci; Elisabetta Vangelista
  7. Pricing zero-coupon CAT bonds using the enlargement of ltration theory: a general framework By Zied Chaieb; Djibril Gueye
  8. Limits of Disclosure Regulation in the Municipal Bond Market By Ivan T. Ivanov; Tom Zimmermann; Nathan Heinrich
  9. Can EU bonds serve as euro-denominated safe assets? By Bletzinger, Tilman; Greif, William; Schwaab, Bernd
  10. Responses of Swiss bond yields and stock prices to ECB policy surprises By Thomas Nitschka; Diego M. Hager
  11. Transformer-Based Deep Learning Model for Stock Price Prediction: A Case Study on Bangladesh Stock Market By Tashreef Muhammad; Anika Bintee Aftab; Md. Mainul Ahsan; Maishameem Meherin Muhu; Muhammad Ibrahim; Shahidul Islam Khan; Mohammad Shafiul Alam

  1. By: Amit Goyal; Alessio Saretto
    Abstract: We show that much of the profitability in equity option return strategies, which try to capture option mispricing by taking exposure to underlying volatility, can be explained by an IPCA model. The alpha reduction, relative to competing static factor models, is between 50% and 75% depending on the computing model and the type of option position.
    Keywords: option returns; IPCA; Alpha
    JEL: G11 G12 G13
    Date: 2022–08–26
  2. By: René M. Stulz; Alvaro G. Taboada; Mathijs A. van Dijk
    Abstract: Bank liquid asset holdings vary significantly across banks and through time. The determinants of liquid asset holdings from the corporate finance literature are not useful to predict banks’ liquid asset holdings. Banks have an investment motive to hold liquid assets, so that when their lending opportunities are better, they hold fewer liquid assets. We find strong support for the investment motive. Large banks hold much more liquid assets after the Global Financial Crisis (GFC), and this change cannot be explained using models of liquid asset holdings estimated before the GFC. We find evidence supportive of the hypothesis that the increase in liquid assets of large banks is due at least in part to the post-GFC regulatory changes.
    JEL: G21 G28
    Date: 2022–08
  3. By: Du, Wenxin (Chicago and FRBNY); Hebert, Benjamin (Stanford); Li, Wenhao (USC)
    Abstract: We document regime change in the U.S. Treasury market post-Global Financial Crisis (GFC): dealers switched from a net short to a net long position in the Treasury market. We first derive bounds on Treasury yields that account for dealer balance sheet costs, which we call the net short and net long curves. We show that actual Treasury yields moved from the net short curve pre-GFC to the net long curve post-GFC, consistent with the shift in the dealers’ net position. We then use a stylized model to demonstrate that increased bond supply and tightening leverage constraints can explain this change in regime. This regime change in turn helps explain negative swap spreads and the co-movement between swap spreads, dealer positions, yield curve slope, and covered-interest-parity violations, and implies changing effects for a wide range of monetary policy and regulatory policy interventions.
    Date: 2022–06
  4. By: Leonid Kogan; Jun Li; Harold Zhang
    Abstract: We show theoretically that variable production costs lower systematic risk of firms’ cash flows if capital and variable inputs are complementary in firms’ production and input prices are pro-cyclical. In our dynamic model, this operating hedge effect is weaker for more profitable firms, giving rise to a gross profitability premium. Moreover, gross profitability and value factors are distinct and negatively correlated, and their premia are not captured by the CAPM. We estimate the model by the simulated method of moments, and find that its main implications for stock returns and cash flow dynamics are quantitatively consistent with the data.
    JEL: E44 G12
    Date: 2022–07
  5. By: Durrani, Agha; Ongena, Steven; Ponte Marques, Aurea
    Abstract: What is the impact of stress tests on bank stock prices? To answer this question we study the impact of the publication of the EU-wide stress tests in 2014, 2016, 2018, and 2021 on the first (λ) and second (δ) moment of equity returns. First, we study the effect of the disclosure of stress tests on (cumulative) excess/abnormal returns through a one-factor market model. Second, we study whether both returns and volatility of bank stock prices changes upon the disclosure of stress tests through a structural GARCH model, developed by Engle and Siriwardane (2018). Our results suggest that the publication of stress tests provides new information to markets. Banks performing poorly in stress tests experience, on average, a reduction in returns and an increase in volatility, while the reverse holds true for banks performing well. Banks performing moderately have rather a small effect on both mean and variance process. Our findings are corroborated by the observed rank correlation between bank abnormal returns or equity volatility and stress test performance, which experiences a steady increase after each publication event. These results suggest that the publication of stress tests improves price discrimination between 'good' and 'bad' banks, which can be interpreted as a certification role of the stress tests in the stock market. JEL Classification: G11, G14, G21, G28
    Keywords: excess return, financial stability, stock markets, stress tests, volatility
    Date: 2022–08
  6. By: Andrea Carriero (Queen Mary University of London, University of Bologna); Lorenzo Ricci (ESM); Elisabetta Vangelista (ESM)
    Abstract: The European Financial Stability Facility (EFSF) was set up in June 2010 as a temporary crisis resolution mechanism. In October 2012, its tasks were taken over by European Stability Mechanism (ESM), a permanent institution with a capital-based structure. Liquidity conditions for EFSF bonds in the secondary market are different from those of large sovereign bond issuers, which affects bond pricing. This paper offers the first study of the term structure of EFSF bond yields and a decomposition into expected interest rates and risk premia, based on a state-of-the-art no-arbitrage term structure model. A joint model of the EFSF curve and the swap curve allows to further identify the liquidity and credit components of both yield curves and disentangle an additional element of liquidity typical of bonds. This component is closely related to the ECB monetary policy. This model can be extended to other supranational institutions.
    Keywords: Term structure, volatility, density forecasting, no arbitrage
    JEL: C32 C53 E43 E47 G12
    Date: 2022–07–29
  7. By: Zied Chaieb; Djibril Gueye
    Abstract: The main goal of this paper is to use the enlargement of ltration framework for pricing zerocoupon CAT bonds. For this purpose, we develop two models where the trigger event time is perfectly covered by an increasing sequence of stopping times with respect to a reference ltration. Hence, depending on the nature of these stopping times the trigger event time can be either accessible or totally inaccessible. When some of these stopping times are not predictable, the trigger event time is totally inaccessible, and very nice mathematical computations can be derived. When the stopping times are predictable, the trigger event time is accessible, and this case would be a meaningful choice for Model 1 from a practical point of view since features like seasonality are already captured by some quantities such as the stochastic intensity of the Poisson process. We compute the main tools for pricing the zero-coupon CAT bond and show that our constructions are more general than some existing models in the literature. We obtain some closed-form prices of zero-coupon CAT bonds in Model 2 so we give a numerical illustrative example for this latter.
    Date: 2022–08
  8. By: Ivan T. Ivanov (Federal Reserve Board); Tom Zimmermann (University of Cologne); Nathan Heinrich (Federal Reserve Board)
    Abstract: We examine recent regulation requiring US municipal governments to disclose private debt. We show that governments fail to disclose 55-80% of reportable debt events and that, conditional on disclosure, filings often omit contract details essential for bond pricing. Non-compliant issuers are also riskier than compliers, with disclosure decreasing in the potential of private debt to adversely affect bondholders. Event studies suggest that disclosure reveals positive news and is especially informative to investors in low-rated bonds or during market turmoil episodes. Overall, private debt disclosure remains largely voluntary, highlighting challenges to recent federal initiatives to increase transparency for municipal bond investors.
    Keywords: Bond pricing, disclosure regulation, private debt
    Date: 2022–08
  9. By: Bletzinger, Tilman; Greif, William; Schwaab, Bernd
    Abstract: A safe asset is of high credit quality, retains its value in bad times, and is traded in liquid markets. We show that bonds issued by the European Union (EU) are widely considered to be of high credit quality, and that their yield spread over German Bunds remained contained during the 2020 Covid-19 pandemic recession. Recent issuances and taps under the EU’s SURE and NGEU initiatives helped improve EU bonds' market liquidity from previously low levels, also reducing liquidity risk premia. Eurosystem purchases and holdings of EU bonds did not impair market liquidity. Currently, one obstacle to EU bonds achieving a genuine euro-denominated safe asset status, approaching that of Bunds, lies in the one-off, time-limited nature of the EU’s Covid-19-related policy responses. JEL Classification: E58, G12, H63
    Keywords: EU-issued bonds, European Central Bank, European Union, market liquidity, NextGenerationEU (NGEU), Pandemic Emergency Purchase Programme (PEPP)
    Date: 2022–08
  10. By: Thomas Nitschka; Diego M. Hager
    Abstract: We analyse spillovers from European Central Bank (ECB) policy surprises to asset markets outside the euro area using Switzerland as a case study. Our results suggest that Swiss asset price responses to ECB policy surprises are significant. They depend on the type and nature of the surprise and change over time. Decomposing bond yields into expected short-term interest rates and the term premium reveals that both signalling and portfolio rebalancing effects explain the responses of bond yields of various maturities to surprises resulting from scheduled ECB policy decisions. ECB policy surprises are more important to Swiss government bond yields than Swiss stock prices.
    Keywords: Bond, event study, international spillovers, monetary policy, stock
    JEL: E43 E52 G15
    Date: 2022
  11. By: Tashreef Muhammad; Anika Bintee Aftab; Md. Mainul Ahsan; Maishameem Meherin Muhu; Muhammad Ibrahim; Shahidul Islam Khan; Mohammad Shafiul Alam
    Abstract: In modern capital market the price of a stock is often considered to be highly volatile and unpredictable because of various social, financial, political and other dynamic factors. With calculated and thoughtful investment, stock market can ensure a handsome profit with minimal capital investment, while incorrect prediction can easily bring catastrophic financial loss to the investors. This paper introduces the application of a recently introduced machine learning model - the Transformer model, to predict the future price of stocks of Dhaka Stock Exchange (DSE), the leading stock exchange in Bangladesh. The transformer model has been widely leveraged for natural language processing and computer vision tasks, but, to the best of our knowledge, has never been used for stock price prediction task at DSE. Recently the introduction of time2vec encoding to represent the time series features has made it possible to employ the transformer model for the stock price prediction. This paper concentrates on the application of transformer-based model to predict the price movement of eight specific stocks listed in DSE based on their historical daily and weekly data. Our experiments demonstrate promising results and acceptable root mean squared error on most of the stocks.
    Date: 2022–08

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