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on Risk Management |
| By: | Justin Wolfers; Eric Zitzewitz |
| Abstract: | While most empirical analysis of prediction markets treats prices of binary options as predictions of the probability of future events, Manski (2004) has recently argued that there is little existing theory supporting this practice. We provide relevant analytic foundations, describing sufficient conditions under which prediction markets prices correspond with mean beliefs. Beyond these specific sufficient conditions, we show that for a broad class of models prediction market prices are usually close to the mean beliefs of traders. The key parameters driving trading behavior in prediction markets are the degree of risk aversion and the distribution on beliefs, and we provide some novel data on the distribution of beliefs in a couple of interesting contexts. We find that prediction markets prices typically provide useful (albeit sometimes biased) estimates of average beliefs about the probability an event occurs. |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:2006-11&r=rmg |
| By: | Hui Guo; Robert Savickas |
| Abstract: | Finance theory, e.g., Campbell's (1993) ICAPM, indicates that the expected equity premium is a linear function of stock market volatility and the volatility of shocks to investment opportunities. We show that one can use average CAPM-based idiosyncratic volatility as a proxy for the latter. In particular, over the period 1927:Q1 to 2005:Q4, stock market volatility and idiosyncratic volatility jointly forecast stock market returns both in sample and out of sample. This finding is robust to alternative measures of idiosyncratic volatility; subsamples; the log transformation of volatility measures; and control for various predictive variables commonly used by early authors. Our results suggest that stock market returns are predictable. |
| Keywords: | Stock exchanges ; Stock - Prices |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2006-019&r=rmg |
| By: | Joel F. Houston; Kevin J. Stiroh |
| Abstract: | This paper examines the evolution of risk in the U.S. financial sector using firm-level equity market data from 1975 to 2005. Over this period, financial sector volatility has steadily increased, reaching extraordinary levels from 1998 to 2002. Much of this recent turbulence can be attributed to a series of major financial shocks, and we find evidence of an upward trend in volatility only for the common component that affects the entire financial sector. While idiosyncratic volatility remains dominant, a combination of common shocks, deregulation, and diversification has reduced its relative importance since the early 1990s. Within the financial sector, commercial banks show the largest rise in volatility, which also reflects industry shocks and not the idiosyncratic component. Despite these changes, we find that the links between the financial sector and economic activity have declined in recent years. These results have implications for investors, bank regulators, and other policymakers concerned with the origins of financial sector risk and with the links between the financial markets and real activity. |
| Keywords: | Risk ; Financial markets ; Banks and banking |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:248&r=rmg |
| By: | Edward J. Kane |
| Abstract: | Considered as a social contract, a financial safety net imposes duties and confers rights on different sectors of the economy. Within a nation, elements of incompleteness inherent in this contract generate principal-agent conflicts that are mitigated by formal agreements, norms, laws, and the principle of democratic accountability. Across nations, additional layers of incompleteness emerge that are hard to moderate. This paper shows that nationalistic biases and leeway in principles used to measure value-at-risk and bank capital make it unlikely that the crisis-prevention and crisis-resolution schemes incorporated in Basel II and EU Directives could allocate losses imbedded in troubled institutions efficiently or fairly across member nations. |
| JEL: | G21 G28 P51 |
| Date: | 2006–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:12170&r=rmg |