New Economics Papers
on Risk Management
Issue of 2006‒01‒29
six papers chosen by

  1. Hot and Cold Housing Markets: International Evidence By Ceron, Jose A.; Suarez, Javier
  2. The Asymmetric Effect of the Business Cycle on the Realtion between Stock Market Returns and their Volatility By P N Smith; S Sorensen; M R Wickens
  3. Extracting Leading Indicators of Bank Fragility from Market Prices – Estonia Focus By Yu-Fu Chen; Michael Funke; Kadri Männasoo
  4. Estimating the Intertemporal Risk-Return Tradeoff Using the Implied Cost of Capital By Pástor, Lubos; Sinha, Meenakshi; Swaminathan, Bhaskaran
  5. Macroeconomic Derivatives: An Initial Analysis of Market-Based Macro Forecasts, Uncertainty and Risk By Gürkaynak, Refet.S.; Wolfers, Justin
  6. Distribution Risk and Equity Returns By Danthine, Jean-Pierre; Donaldson, John B; Siconolfi, Paolo

  1. By: Ceron, Jose A.; Suarez, Javier
    Abstract: This paper examines the experience of 14 developed countries for which there are about 30 years of quarterly inflation-adjusted housing price data. Price dynamics is modelled as a combination of a country-specific component and a cyclical component. The cyclical component is a two-state Markov switching process with parameters common to all countries. We find that the latent cyclical variable captures previously undocumented changes in the volatility of real housing price increases. These volatility phases are quite persistent (about six years, on average) and occur with about the same unconditional frequency over time. In line with previous studies, the mean of real housing price increases can be predicted to be larger when lagged values of those increases are large, real GDP growth is high, unemployment falls, and interest rates are low or have declined. Our findings have important implications for risk management in regard to residential property markets.
    Keywords: cycles; housing prices; Markov switching; volatility
    JEL: E32 G15 R31
    Date: 2006–01
  2. By: P N Smith; S Sorensen; M R Wickens
    Abstract: We examine the relation between US stock market returns and the US business cycle for the period 1960 - 2003 using a new methodology that allows us to estimate a time-varying equity premium. We identify two channels in the transmission mechanism. One is through the mean of stock returns via the equity risk premium, and the other is through the volatility of returns. We provide support for previous findings based on simple correlation analysis that the relation is asymmetric with downturns in the business cycle having a greater negative impact on stock returns than the positive effect of upturns. We also obtain a new result, that demand and supply shocks affect stock returns differently. Our model of the relation between returns and their volatility encompasses CAPM, consumption CAPM and Merton's (1973) inter-temporal CAPM. It is implemented using a multi-variate GARCH-in-mean model with an asymmetric time-varying conditional heteroskedasticity and correlation structure.
    Keywords: Equity returns, risk premium, asymmetry
    JEL: G12 C32 C51
    Date: 2006–01
  3. By: Yu-Fu Chen; Michael Funke; Kadri Männasoo
    Abstract: Banking reform has proved to be one of the most problematic elements of economic transition in central and Eastern Europe. Therefore the paper considers the development of the Estonian banking sector and derives individual banks´ fragility scores during transition. To this end we use option-based tools and equity prices to estimate distance-to-default measures of banks´ distress probabilities. Overall, the results suggest that market indicators are moderately useful for anticipating future financial distress and rating changes in transition economies. The implication for an effective supervisory framework is to use a plurality of risk scores when assessing bank vulnerability.
    Keywords: banking, financial stability, bank fragility, options, Estonia
    JEL: E44 E58 G21
    Date: 2006
  4. By: Pástor, Lubos; Sinha, Meenakshi; Swaminathan, Bhaskaran
    Abstract: We re-examine the time-series relation between the conditional mean and variance of stock market returns. To proxy for the conditional mean return, we use the implied cost of capital, computed using analyst forecasts. The usefulness of this proxy is shown in simulations. In empirical analysis, we construct the time series of the implied cost of capital for the G-7 countries. We find strong support for a positive intertemporal mean-variance relation at both the country level and the world market level. Some of our evidence is consistent with international integration of the G-7 financial markets.
    Keywords: implied cost of capital; international integration; risk-return tradeoff
    JEL: G1
    Date: 2006–01
  5. By: Gürkaynak, Refet.S.; Wolfers, Justin
    Abstract: September 2002, a new market in 'Economic Derivatives' was launched allowing traders to take positions on future values of several macroeconomic data releases. We provide an initial analysis of the prices of these options. We find that market-based measures of expectations are similar to survey-based forecasts although the market-based measures somewhat more accurately predict financial market responses to surprises in data. These markets also provide implied probabilities of the full range of specific outcomes, allowing us to measure uncertainty, assess its driving forces, and compare this measure of uncertainty with the dispersion of point-estimates among individual forecasters (a measure of disagreement). We also assess the accuracy of market-generated probability density forecasts. A consistent theme is that few of the behavioural anomalies present in surveys of professional forecasts survive in equilibrium, and that these markets are remarkably well calibrated. Finally we assess the role of risk, finding little evidence that risk-aversion drives a wedge between market prices and probabilities in this market.
    Keywords: density forecasts; disagreement; economic derivatives; expectations; forecasting; macroeconomic surveys; prediction markets; surveys; uncertainty
    JEL: C5 C82 D8 E3 G14
    Date: 2006–01
  6. By: Danthine, Jean-Pierre; Donaldson, John B; Siconolfi, Paolo
    Abstract: In this paper we entertain the hypothesis that observed variations in income shares are the result of changes in the balance of power between workers and capital owners in labour relations. We show that this view implies that income share variations represent a risk factor of first-order importance for the owners of capital and, consequently, are a crucial determinant of the return to equity. When both risks are calibrated to observations, this distribution risk dominates in importance the usual systematic risk for the pricing of assets. We also show that distribution risks may originate in non-traded idiosyncratic income shocks.
    Keywords: distribution risk; equity premium; income shares; limited market participation
    JEL: E3 G1
    Date: 2006–01

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