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

  1. Mutual Fund Allocations that Maximize Safe Portfolio Returns By Prendergast, Michael
  2. Investor Sentiment in Asset Pricing Models: A Review By Szymon Lis
  3. Stock Liquidity and Firm-Level Political Risk By Kuntal K. Das; Mona Yaghoubi
  4. Constrained Liquidity Provision in Currency Markets By Wenqian Huang; Angelo Ranaldo; Andreas Schrimpf; Fabricius Somogyi
  5. Credit Market Freedom and Corporate Decisions By Andrea Calef; Ifigenia Georgiou; Alfonsina Iona
  6. Insensitive Investors By Constantin Charles; Cary D. Frydman; Mete Kilic
  7. Dynamic Estimates Of The Arrow-Pratt Absolute And Relative Risk Aversion Coefficients By George Samartzis; Nikitas Pittis
  8. Bank competition and bargaining over refinancing By Marina Emiris; François Koulischer; Christophe Spaenjers
  9. Optimal GDP-indexed Bonds By Sandra Daudignon; Oreste Tristani
  10. Efficient implementation of portfolio strategies involving cryptocurrencies and VIX INDEX and Gold By Jiahao Cui; Qiushi Li; Yuezhi Pen
  11. Population aging and bank risk-taking By Sebastian Doerr; Gazi Kabas; Steven Ongena
  12. Efficient Integration of Multi-Order Dynamics and Internal Dynamics in Stock Movement Prediction By Thanh Trung Huynh; Minh Hieu Nguyen; Thanh Tam Nguyen; Phi Le Nguyen; Matthias Weidlich; Quoc Viet Hung Nguyen; Karl Aberer
  13. Too Complex to Digest? Federal Tax Bills and Their Processing in US Financial Markets By Hamza Bennani; Matthias Neuenkirch
  14. Mexico: Financial Sector Assessment Program-Technical Note on Systemic Liquidity Management By International Monetary Fund
  15. Performance of quality factor in Indian Equity Market By Joshy Jacob; Pradeep K.P.; Jayanth R.Varma

  1. By: Prendergast, Michael
    Abstract: This paper describes an empirical analysis of optimized portfolios and safe return rates across multiple investment time horizons using Telser’s Safety-First method. The analysis uses thirty years of historical monthly data for 81 different Fidelity® mutual funds and a blended money market fund rate. The Fidelity® funds represent a wide variety of investment factors, strategies and asset types, including bonds, stocks, commodities and convertible securities. A large synthetic return dataset was generated from this data by a Monte-Carlo random walk using cointegrated bootstrapping of investment returns and yields. Portfolio optimization was then performed on this synthetic dataset for safety factors varying from 60% to 99% and time horizons varying from one month to ten years. Results from portfolio analyses include the following: 1) there are no risk-free investments available to Fidelity® mutual fund investors, as even money market funds have risk due to yield fluctuations, 2) optimized portfolios are sensitive to both investment time horizons and safety factor confidence levels, 3) conservative, short-term investors are better off leaving their money in a money market fund than investing in securities, 4) optimized portfolios for longer term, more aggressive investors consist of a blend of both value and growth equities, and 5) the funds most often represented in optimized portfolios are those that have the best risk/reward ratios, although this rule is not universal. Two practical applications of this optimization approach are also presented.
    Date: 2022–09–30
  2. By: Szymon Lis (University of Warsaw, Faculty of Economic Sciences, Department of Quantitative Finance)
    Abstract: Despite the number of works on investor sentiment in asset pricing models the results did not allow to obtain a coherent knowledge about this sentiment. Most of the researchers used different measures and various models to study the impact of sentiment on stocks returns. However, the empirical relationship between investor sentiment and stock market behavior remains unclear. This study focuses on reviewing the methodologies and empirical findings of 71 papers published between 2000 and 2021 that apply different investor sentiment measures for modeling returns. The research confirmed two out of the three research hypotheses that the investor sentiment proxies and higher complexity of the model with the investor sentiment indicator improve the coefficient of determination. The second one was rejected, however, this may be due to too small a sample. For the hypothesis that models with more complex sentiment have better predictive power than those with simpler proxies, the number of studies was insufficient to refer strongly to the hypothesis.
    Keywords: Investor sentiment, Asset pricing, Multifactor models, Behavioral finance, Risk factors, stock market behavior
    JEL: G11 G12 G14 G40
    Date: 2022
  3. By: Kuntal K. Das (University of Canterbury); Mona Yaghoubi (University of Canterbury)
    Abstract: Exploiting a novel measure of firm-level political risk based on earnings conference calls, we examine the effect of firm-level political risk on stock liquidity. We show that liquidity decreases significantly more in firms that are exposed to political risk. An increase in firm-level political risk by one standard deviation lowers liquidity by around 3.64%. We further investigate whether the effect of firm-level political risk on stock liquidity can be mitigated or exacerbated by the political environment of the U.S. economy and find some evidence of the Democratic liquidity premium. Our results are robust to alternative measures of (il)liquidity, and an estimation method.
    Keywords: Stock liquidity, political risk
    JEL: G11 G14
    Date: 2022–11–01
  4. By: Wenqian Huang (Bank for International Settlements); Angelo Ranaldo (University of St. Gallen; Swiss Finance Institute); Andreas Schrimpf (CREATES - Aarhus University; Bank for International Settlements (BIS) - Monetary and Economic Department); Fabricius Somogyi (D’Amore-McKim School of Business)
    Abstract: We study dealers’ liquidity provision in the currency market. We show that at times when dealers’ intermediation capacity is constrained their cost of liquidity provision increases disproportionately relative to dealer-provided volume. As a result, the elasticity of dealers’ liquidity provision weakens by at least 80% relative to periods when they are unconstrained. We identify constrained periods based on leverage ratios, Value-at-Risk measures, credit default spreads, and debt funding costs. We interpret our novel empirical findings within a parsimonious model that sheds light on the key mechanisms of how liquidity provision by dealers tends to weaken when intermediary constraints are tightening.
    Keywords: Currency markets, dealer constraints, market liquidity, foreign exchange, liquidity provision.
    JEL: F31 G12 G15
    Date: 2022–10
  5. By: Andrea Calef (School of Economics, University of East Anglia); Ifigenia Georgiou (School of Business, University of Nicosia); Alfonsina Iona (School of Economics and Finance, Queen Mary University of London)
    Abstract: Despite the extensive empirical evidence of a positive impact of economic freedom on economic growth, the influence of economic freedom and its components on a firm’s level of cash, leverage and investment remains an unexplored issue in microeconomics and corporate finance research. In this study, we contribute towards filling this gap by examining whether Credit Market Freedom - an important component of the Economic Freedom Index – influences corporate decisions. In particular, we study whether and to what extent Credit Market Freedom affects a firm’s target level of investment, cash holdings, and leverage. We observe the behavior of a large and heterogeneous sample of North American non-financial firms over the period 2000-2019. Our empirical results suggest that higher Credit Market Freedom is associated with a healthier corporate capital structure, higher financial flexibility, and a friendlier investment environment.
    Keywords: Economic Freedom, Corporate Decisions, Capital Structure
    JEL: G10 G18 G30 G31
    Date: 2022–11
  6. By: Constantin Charles; Cary D. Frydman; Mete Kilic
    Abstract: We show theoretically that the weak transmission of beliefs to actions induces a strong bias in basic asset pricing tests. In particular, expected returns can appear to decline in risk when investors weakly transmit their payoff expectations into willingness to pay. We experimentally test this prediction and find that subjects exhibit an extremely weak transmission of beliefs to actions, which generates a negative risk-return relation. We argue that the weak transmission is due to cognitive noise and demonstrate that cognitive noise causally affects the risk-return relation. Our results highlight the importance of incorporating weak transmission into belief-based asset pricing models.
    Keywords: investor behavior, cognitive noise, portfolio choice
    Date: 2022
  7. By: George Samartzis; Nikitas Pittis
    Abstract: We derive a closed-form expression capturing the degree of Relative Risk Aversion (RRA) of investors for non-"fair" lotteries. We argue that our formula is superior to earlier methods that have been proposed, as it is a function of only three variables. Namely, the Treasury yields, the returns and the market capitalization of a specific market index. Our formula, is tested on CAC 40, EURO, S&P 500 and STOXX 600, with respect to the market capitalization of each index, for different time periods. We deduce that the investors in these markets exhibit Decreasing Absolute Risk Aversion (DARA) through all the different time periods that we consider, while the degree of RRA has altered between being constant, decreasing or increasing. Furthermore, we propose a simple and intuitive way to measure the degree to which a wrong assumption with respect to the utility function of an investor will affect the structure of his portfolio. Our method is built on a two asset portfolio framework. Namely, a portfolio consisting of one risky and one risk-free asset. Applying our method, the empirical findings indicate that the weight invested in the risky asset varies substantially even among utility functions with similar characteristics.
    Date: 2022–11
  8. By: Marina Emiris (: Economics and Research Department, National Bank of Belgium); François Koulischer (University of Luxembourg); Christophe Spaenjers (Leeds School of Business, University of Colorado Boulder)
    Abstract: We model mortgage refinancing as a bargaining game involving the borrowing household, the incumbent lender, and an outside bank. In equilibrium, the borrower’s ability to refinance depends both on the competitiveness of the local banking market and on the cost of switching banks. We find empirical support for the key predictions of our model using a unique data set containing the population of mortgages in Belgium. In particular, households’ refinancing propensities are positively correlated with the number of local branches and negatively correlated with local mortgage market concentration. Moreover, households are more likely to refinance externally if they already have a relation with more than one bank, but the effect is mitigated if their current mortgage lender has a branch locally.
    Keywords: mortgage markets; refinancing; bargaining; bank competition; switching costs
    Date: 2022–10
  9. By: Sandra Daudignon; Oreste Tristani (-)
    Abstract: Empirical analyses starting from Laubach and Williams (2003) find that the natural rate of interest is not constant in the long-run. This paper studies the optimal response to stochastic changes of the long-run natural rate in a suitably modified version of the new Keynesian model. We show that, because of the zero lower bound (ZLB) on nominal interest rates, movements towards zero of the long-run natural rate cause an increasingly large downward bias in expectations. To offset this bias, the central bank should aim to keep the real interest rate systematically below the long-run natural rate, as long as policy is not constrained by the ZLB. The neutral rate – the level of the policy rate consistent with stable inflation and the natural rate at its long-run level – will be lower than the long-run natural rate. This is the case both under optimal policy, and under a price level targeting rule. In the latter case, the neutral rate is equal to zero as soon as the long-run natural rate falls below 1%.
    Keywords: nonlinear optimal policy, zero lower bound, commitment, liquidity trap, New Keynesian, natural rate of interest
    JEL: C63 E31 E52
    Date: 2022–11
  10. By: Jiahao Cui; Qiushi Li; Yuezhi Pen
    Abstract: This research mainly explores the characteristics of different strategies and whether VIX INDEX positively influences the investment portfolio in any period. Our portfolio has six significant cryptocurrencies, VIX INDEX and gold. We perform parameter estimation on all raw data and bring the two types into different investment strategies, complete them effectively according to other characteristics, and compare the results. At the same time, we make two different portfolios, one contains VIX INDEX, and one does not have VIX INDEX. We use different portfolios in different portfolio strategies and find that VIX INDEX can positively impact the investment portfolio of cryptocurrencies, no matter in the standard market or the downward market. The research shows that gold has the same attributes as VIX INDEX and should have a specific positive effect, but no comparative experiment has been done.
    Date: 2022–11
  11. By: Sebastian Doerr; Gazi Kabas; Steven Ongena
    Abstract: What are the implications of an aging population for financial stability? To examine this question, we exploit geographic variation in aging across U.S. counties. We establish that banks with higher exposure to aging counties increase loan-to-income ratios, especially where they operate no branches. Laxer lending standards also lead to higher nonperforming loans during downturns, suggesting higher credit risk. Inspecting the mechanism shows that aging drives risk-taking through two contemporaneous channels: deposit in ows due to seniors' propensity to save in deposits; and depressed local investment opportunities due to seniors' lower credit demand. Banks thus look for riskier clients in no-branch counties.
    Keywords: risk-taking, financial stability, low interest rates, population aging, demographics.
    JEL: E51 G21
    Date: 2022–11
  12. By: Thanh Trung Huynh; Minh Hieu Nguyen; Thanh Tam Nguyen; Phi Le Nguyen; Matthias Weidlich; Quoc Viet Hung Nguyen; Karl Aberer
    Abstract: Advances in deep neural network (DNN) architectures have enabled new prediction techniques for stock market data. Unlike other multivariate time-series data, stock markets show two unique characteristics: (i) \emph{multi-order dynamics}, as stock prices are affected by strong non-pairwise correlations (e.g., within the same industry); and (ii) \emph{internal dynamics}, as each individual stock shows some particular behaviour. Recent DNN-based methods capture multi-order dynamics using hypergraphs, but rely on the Fourier basis in the convolution, which is both inefficient and ineffective. In addition, they largely ignore internal dynamics by adopting the same model for each stock, which implies a severe information loss. In this paper, we propose a framework for stock movement prediction to overcome the above issues. Specifically, the framework includes temporal generative filters that implement a memory-based mechanism onto an LSTM network in an attempt to learn individual patterns per stock. Moreover, we employ hypergraph attentions to capture the non-pairwise correlations. Here, using the wavelet basis instead of the Fourier basis, enables us to simplify the message passing and focus on the localized convolution. Experiments with US market data over six years show that our framework outperforms state-of-the-art methods in terms of profit and stability. Our source code and data are available at \url{ 3/estimate}.
    Date: 2022–11
  13. By: Hamza Bennani; Matthias Neuenkirch
    Abstract: In this paper, we analyze whether the complexity of tax bills affects financial markets. Based on the Flesch-Kincaid grade level of the 32 tax bills identified by Romer and Romer (2010) in the period 1962–2003, we assess the relationship between tax bills’ complexity and financial markets using an event study approach. Our results show a negative (positive) and significant relationship between the present value of tax bills and changes in the 10-year government bond yields (S&P 500 returns). The magnitude of this relationship increases over time, suggesting that market participants underreact at first and need a couple of days to digest the information contained in the tax bills. This delay can be explained by the textual characteristics of the bills in the case of the 10-year yields as a lower readability partly offsets the negative relationship for up to three days after the signing of a tax bill, but not thereafter. In the case of the stock market, we find similar offsetting evidence, but only for a part of the readability measures employed in this paper.
    Keywords: complexity, event study, financial markets, readability, tax bills
    JEL: G14 H20 H30
    Date: 2022
  14. By: International Monetary Fund
    Abstract: Mexican money markets are well-regulated and function efficiently, with significant mitigants to systemic liquidity risks. This is supported by the dominance of the repo market in system-wide liquidity management, the marginal level of interbank unsecured transactions, as well as commercial banks’ full compliance with the Liquidity Coverage Ratio (LCR). However, development banks are not subject to liquidity regulation. These banks have development objectives and the sovereign backstops their capitalization and explicitly guarantees all of their liabilities, however, some of them have a significant reliance on short-term funding with low levels of unencumbered high-quality liquid assets. This might contribute to systemic liquidity risk during periods of extreme market stress in severe tail risk scenarios. Thus, the authorities could consider steps to strengthen the development banks’ liquidity risk management framework by improving the monitoring of their liquidity, leveraging their internal risk committees to take stock of their risk profile and contribution to systemic risk, making use of Pillar 2 requirements, and/or devising appropriate action(s) to improve these entities’ maturity transformation.
    Keywords: development bank; Banco de México; standing liquidity; ELA framework; liquidity support; government bond bond market; Liquidity; Lender of last resort; Collateral; Commercial banks; Securities; Global
    Date: 2022–11–10
  15. By: Joshy Jacob; Pradeep K.P.; Jayanth R.Varma
    Abstract: We study the characteristics of Quality factor (QMJ) in India, which is the second largest emerging market. Dimensions of quality factor are impacted by the weaker enforcement of corporate governance norms in emerging markets. Diversion of revenues by promoters would result in poor profitability, while tunneling of profits would result in lower payout and lower growth. Therefore, investors are likely to attach greater significance to the quality dimensions in stock pricing. Consistent with this hypothesis, the Quality factor is even more important for asset pricing in India than in developed markets. The QMJ factor earns a four factor alpha of 0.92% per month, significantly outperforming the other widely employed factors, market, size, value and momentum factors. A long-only Quality factor earns an alpha of 0.69% per month. The alpha of quality factors is highly significant, judged by the thresholds recommended by Harvey, Liu, and Zhu (2016). The key drivers of the alpha are profitability and payout, which are both consistent with the tunnelling hypothesis. Besides the alpha, the low portfolio churn, lower risk, shorter drawdowns, and viability of long-only strategies restricted to large capitalization stocks suggest that portfolios tilted towards high-quality stocks are highly attractive to institutional and retail investors.
    Date: 2022–11–23

This nep-fmk issue is ©2022 by Kwang Soo Cheong. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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