New Economics Papers
on Risk Management
Issue of 2006‒05‒27
eight papers chosen by

  1. Have European Stocks Become More Volatile? An Empirical Investigation of Idiosyncratic and Market Risk in the Euro Area By Colm Kearney; Valerio Poti
  2. Portfolio management implications of volatility shifts: Evidence from simulated data By Viviana Fernandez; Brian M. Lucey
  3. Portfolio allocations in the Middle East and North Africa By Thomas Lagoarde-Segot; Brian M. Lucey
  4. Who tames the Celtic tiger? portfolio implications from a multivariate Markov switching model By Massimo Guidolin; Stuart Hyde
  5. Investing for the long-run in European real estate By Carolina Fugazza; Massimo Guidolin; Giovanna Nicodano
  7. Federal Securities Regulations and Stock Market Returns By Tung Liu; Gary Santoni; Courtenay Cliff Stone
  8. The Evolution of Interdependence in World Equity Markets - Evidence from Minimum Spanning Trees By Ricardo Coehlo; Claire Gilmore; Brian M. Lucey

  1. By: Colm Kearney; Valerio Poti
    Abstract: We examine the dynamics of idiosyncratic risk, market risk and return correlations in European equity markets using weekly observations from 3515 stocks listed in the 12 Euro area stock markets over the period 1974-2004. Similarly to Campbell, Lettau, Malkiel and Xu (2001), we find a rise in idiosyncratic volatility, implying that it now takes more stocks to diversify away idiosyncratic risk. Contrary to the United States , however, market risk is trended upwards in Europe and correlations are not trended downwards. Both the volatility and correlation measures are pro-cyclical, and they rise during times of low market returns. Market and average idiosyncratic volatility jointly predict market wide returns, and the latter impact upon both market and idiosyncratic volatility. This has asset pricing and risk management implications.
    Keywords: Idiosyncratic risk, correlation, portfolio management, asset pricing
    Date: 2006–05–23
  2. By: Viviana Fernandez; Brian M. Lucey
    Abstract: Based on weekly data of the Dow Jones Country Titans, the CBT-municipal bond, spot and futures prices of commodities for the period 1992-2005, we analyze the implications for portfolio management of accounting for conditional heteroskedasticity and structural breaks in long-term volatility. In doing so, we first proceed to utilize the ICSS algorithm to detect volatility shifts, and incorporate that information into PGARCH models fitted to the returns series. At the next stage, we simulate returns series and compute a wavelet-based value at risk, which takes into consideration the investor’s time horizon. We repeat the same procedure for artificial data generated from distribution functions fitted to the returns by a semi-parametric procedure, which accounts for fat tails. Our estimation results show that neglecting GARCH effects and volatility shifts may lead us to overestimate financial risk at different time horizons. In addition, we conclude that investors benefit from holding commodities as their low or even negative correlation with stock indices contribute to portfolio diversification.
    Keywords: volatility shifts, wavelets, value at risk
    Date: 2006–05–23
  3. By: Thomas Lagoarde-Segot; Brian M. Lucey
    Abstract: We examine the issue of possible portfolio diversification benefits into seven Middle-Eastern and North African (MENA) stock markets. We construct international portfolios in dollars and local currencies. We compute the ex-ante weights by plugging five optimization models and two risk measures into a rolling block-bootstrap methodology. This allows us to derive 48 monthly rebalanced ex-post portfolio returns. We analyze the out-of-sample performance based on Sharpe and Sortino ratios and the Jobson-Korkie statistic. Our results highlight outstanding diversification benefits in the MENA region, both in dollar and local currencies. Overall, we show that these under-estimated, under-investigated markets could attract more portfolio flows in the future.
    Keywords: Portfolio Allocation, Emerging Markets, Middle East and North Africa.
    Date: 2006–05–25
  4. By: Massimo Guidolin; Stuart Hyde
    Abstract: We calculate optimal portfolio choices for a long-horizon, We use multivariate regime switching vector autoregressive models to characterize the time-varying linkages among the Irish stock market, one of the top world performers of the 1990s, and the US and UK stock markets. We find that two regimes, characterized as bear and bull states, are required to characterize the dynamics of excess equity returns both at the univariate and multivariate level. This implies that the regimes driving the small open economy stock market are largely synchronous with those typical of the major markets. However, despite the existence of a persistent bull state in which the correlations among Irish and UK and US excess returns are low, we find that state comovements involving the three markets are so relevant to reduce the optimal mean variance weight carried by ISEQ stocks to at most one-quarter of the overall equity portfolio. We compute time-varying Sharpe ratios and recursive mean-variance portfolio weights and document that a regime switching framework produces out-of-sample portfolio performance that outperforms simpler models that ignore regimes. These results appear robust to endogenizing the effects of short term interest rates on excess stock returns.
    Keywords: Stock exchanges
    Date: 2006
  5. By: Carolina Fugazza; Massimo Guidolin; Giovanna Nicodano
    Abstract: We calculate optimal portfolio choices for a long-horizon, risk-averse investor who diversifies among European stocks, bonds, real estate, and cash, when excess asset returns are predictable. Simulations are performed for scenarios involving different risk aversion levels, horizons, and statistical models capturing predictability in risk premia. Importantly, under one of the scenarios, the investor takes into account the parameter uncertainty implied by the use of estimated coefficients to characterize predictability. We find that real estate ought to play a significant role in optimal portfolio choices, with weights between 12 and 44 percent. Under plausible assumptions, the welfare costs of either ignoring predictability or restricting portfolio choices to traditional financial assets only are found to be in the order of 150-300 basis points per year. These results are robust to changes in the benchmarks and in the statistical framework.
    Keywords: Real estate investment ; Rate of return ; European Union
    Date: 2006
  6. By: Juan Ignacio Pena; Santiago Forte
    Abstract: This paper presents a procedure for computing homogeneous measures of credit risk from stocks, bonds and CDSs. The measures are based on bond spreads (BS), CDS spreads (CDS) and implied stock market credit spreads (ICS). We compute these measures for a sample of North American and European firms and find that in most cases, the stock market leads the credit risk discovery process with respect to bond and CDS markets.
    Date: 2006–05
  7. By: Tung Liu (Department of Economics, Ball State University); Gary Santoni (Department of Economics, Ball State University); Courtenay Cliff Stone (Department of Economics, Ball State University)
    Abstract: This paper examines the impact of federal securities statutes (seven major legislative acts and 535 amendments) on the mean and variance of total real U.S. stock market returns. In contrast to previous work, this study controls for the persistence of the variability of stock returns, employs a longer time period, utilizes a broader array of stocks and examines the impact of seven federal securities regulations and their selected amendments from 1933 through 2001. Despite the popular appeal of this legislation, our results indicate that these federal securities statutes and amendments have had no statistical impact on the mean or variance of total real stock returns over the past 70 years.
    Keywords: stock returns, volatility, regulation
    JEL: G14 G18
    Date: 2005–01
  8. By: Ricardo Coehlo; Claire Gilmore; Brian M. Lucey
    Abstract: The minimum spanning tree concept from physics is used to study the process of market integration for a large group of national stock market indices. We show how the tree grows over time and describe the dynamics of its various characteristics. Over the period studied, 1997-2006, the tree shows a tendency to become less bushy. This implies that global equity markets are increasingly interrelated. The consequence for global investors is a potential reduction of the benefits of international portfolio diversification.
    Keywords: Econophysics, minimal spanning trees
    Date: 2006–05–25

General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.